The Advantages & Disadvantages of Incorporating in Delaware
Are you a biotechnology or life sciences startup co-founder? Have you recently incorporated your early-stage startup? Like entrepreneurs in other industries, you may be deciding whether or not to incorporate your new company in your home state, or whether to research alternatives instead.
Incorporating, simply put, is a legal process through which you form a corporate entity or company. There are numerous reasons why a startup founder would want to incorporate their business in the first place, one of which includes the ability to more easily raise funds with certain types of investors, including venture capitalists and angel investors, who generally prefer to invest in C-corporations because of their corporate structure and tax characteristics.
Deciding on where to incorporate seems like it would be straightforward though, doesn’t it? Founders might initially opt to form a corporation in the state where they operate. However, this might not always be the most advantageous choice. Certain states, such as Delaware, Nevada, and Wyoming, are known for offering potentially more business-friendly policies, taxes, and fees.
So, as you can see, after you’ve incorporated your new business, you will also have to consider whether or not to incorporate in the state you operate in or in another state—one with potentially more advantageous policies, taxes, and fees than your own.
Delaware, Wyoming, New York, and Nevada are considered ideal states to incorporate in because of business-friendly taxes, inexpensive legal fees, policies, enhanced privacy protection, specialized courts, and the largest body of corporate law in the nation.
However, in this article, we will only focus on the benefits and drawbacks of incorporating in Delaware. Hopefully, this review will help you make a more informed decision about incorporating your biotech company.
This article is informative. It is not meant to represent legal advice. Before incorporating your business or raising capital through equity financing, it is best practice to speak with a corporate attorney who has a track record in Delaware state law, startups, and venture capital deals.
Incorporating a Life Sciences Company in Delaware
Long considered the “incorporation capital of America”, Delaware’s popularity with businesses and investors—over 60% of Fortune 500 companies are incorporated there—comes from its long-established and favorable corporate law, minimal filing fees, low taxes, a court system adept in complicated corporate issues, flexible corporate structure, and a robust industry of intellectual property experts.
While a state like California is much larger, it doesn’t close the same volume of litigation on corporate law issues that Delaware does. A high volume of litigation is important because it means you can find definite answers in Delaware’s case law that are often undecided in other states.
Incorporating in any state other than Delaware may affect your ability to fundraise. That said, if a VC likes your team and idea, they simply might ask that you reincorporate in Delaware. If you and your co-founders know you want to raise venture capital from the beginning, it is, it’s worth considering incorporating in Delaware right away, to save yourself from going through the process later on.
Despite its popularity, the Delaware incorporation model is not a one-size-fits-all solution. For instance, while many large companies notice the benefits, small businesses may never see them, and in some cases, may even add cost and complexity to their lives/companies by doing so.
What You’ll Need to Do to Incorporate
To incorporate a new or established business in Delaware, you’ll need to take several steps, which we’ll outline below.
But, you should still read through all of Delaware’s Division of Corporation’s information to fully understand the incorporation process, as this list is not comprehensive. There may be other forms you need to fill out and submit to complete the process.
Furthermore, you should also seek legal advice from an attorney or CPA that is familiar with Delaware state law to ensure you’re doing things correctly.
- Choose a business entity type:
There are multiple options to choose from when you’re forming a Delaware corporation. C-corporations, or C-corps, are the default, and are considered the most popular. However, you may find that the non-profit, close, B-, or S-corporation match your business model more closely, and provide you with a good balance of legal protection and benefits.
- Name your corporation:
If you’re business already has a name, you will most likely be able to incorporate using that name. However, if you don’t have a name already, you’ll have to first choose one for the new corporation. You probably won’t face any problems, as long as the name isn’t taken and meets all of Delaware’s corporation naming guidelines. If you’re having trouble deciding on a name, or want to know what’s allowed and prohibited, you can review Delaware’s naming requirements.
- Appoint a Registered Agent:
Your corporation must have an agent for service of process in the state, one that acts as the liaison between the corporation and the state it’s incorporated in. The registered agent is an individual or corporation that agrees to accept legal papers on the corporation’s behalf if it is sued, and is either a resident of Delaware or a business entity authorized to do business in the state. The individual or business must have a physical street address in the state as well.
If your corporation is physically located in Delaware, it will be able to act as its own registered agent.
Appointing a registered agent requires a fee, which can vary depending on who you’re working with. If you’re interested in learning more about the available agents, the Delaware Division of Corporation includes a Delaware Registered Agents list on their website.
- File Articles of Incorporation:
The Articles of Incorporation, or Certificate of Incorporation, are documents you must file in order to actually form your corporation. You file these documents with the Delaware Secretary of State, which reviews the articles and approves or denies them.
The articles can be found online or mailed to you, depending on your preference. They must include your corporation’s name, the registered office address, the name of the registered agent for service of process located in Delaware, and the name, address and signature of the person authorized to file the certificate, known as the “incorporator”. Additionally, if you are a stock corporation, you must include the number of shares you are authorizing to issue, their par value, and your business’s purpose.
If you file online, a Filing Cover Memo will be automatically created, however, if you file through the mail, you need to include one on your own. There is a minimum fee for filing, which is $89 and provides 1,500 shares of no par value stock or up to $75,000 of par value stock.
- Determine the corporation’s Director or Directors:
Delaware requires that the corporation you form has at least one director. Selecting one releases the corporation as the incorporator, i.e., the person who signed the articles of incorporation, as well.
Furthermore, the incorporator must fill in an “Incorporator’s Statement” showing the names and addresses of the selected directors. The statement must be signed by the incorporate, and a copy must be placed n the corporate records book. However, the statement does not need to be filed with the state, as it will not appear on any public record and doesn’t limit your ability to name other people to the corporation’s Board of Directors.
- Determine the corporation’s stock information:
When filing a general and close corporation, the amount of stock for your company and the par value of its shares needs to be authorized, whether or not you plan to issue stock. Delaware franchise taxes are based on your total shares. For this reason, some corporation owners prefer to keep the number of shares low whenever possible.
When you form a corporation, plan to authorize what you’ll need or think you may need. Corporations with 5,000 or less authorized shares pay the minimum franchise tax each year.
Those that exceed 5,000 shares can recalculate the corporation’s franchise tax using the Assumed Par Value Capital Method and the Authorizing Shares Method. Both methods of calculating franchise tax are outlined on Delaware’s government website.
- Obtain an EIN
All C and S corporations need an EIN, also known as a federal employer identification number. It must be obtained before opening a US bank account, hiring US employees, or paying US taxes. EINs are considered a type of taxpayer identification number, or TIN, and allow the IRS to track wages, payments, and any other related expenses from the corporation to its owners and employees.
An EIN establishes a business bank account separate from your personal bank account, and is free of charge to set up.
- File Your Annual Report and Franchise Tax
This isn’t necessarily a part of the incorporating process, but, after you’ve incorporated, you’ll need to fulfill certain ongoing requirements to maintain good standing with the state. This includes filing an annual report and paying your franchise taxes each year. The report can be filed online.
Each year, both the annual report and franchise taxes must be received by the Delaware Division of Corporations on or before March 1st. If you’re a foreign corporation, you must file an annual report by June 30th.
The filing fee for domestic corporations is $50, plus franchise taxes, due upon filing the report. The filing fee for foreign corporations is a little more expensive and costs $125.
The minimum franchise tax is $175, with a maximum tax of $200,000. Corporations that owe $5,000 or more will pay estimated taxes in quarterly installments with 40% due June 1st; 20% due by September 1st; 20% due by December 1st; and the remainder due before or on March 1st. You can use the Delaware Franchise Tax Calculator to obtain more details.
Note: It’s also important to establish your corporate bylaws, the rules a company adopts in order to determine stockholder, board member, and officer information, stockholder meeting procedures, stockholder and officer duties, voting procedures and regulations, rules to amend bylaws, and the corporation’s name and address, among other rules that help a business run smoothly.
The Advantages of Incorporating in Delaware
The Delaware court system is well-established
There is a corporation court in Delaware, referred to as the Court of Chancery, which is largely dedicated to corporate litigation. The judges, chosen through a rather non-political process, are experts of corporate law and the decisions made from the court are typically more predictable than those in other states.
Additionally, appeals from the Chancery Court are taken directly to the Delaware Supreme Court, whose members also spend a large amount of time handling corporate law and questions.
To remain neutral, the state does not provide any sort of “home court advantage.” Neutrality is achieved through Delaware’s legislature, which is designed to value its incorporation franchise above any individual or company, regardless of company or political donation size. Changes to the corporations code are made with caution, at the suggestion of a panel of non-partisan experts.
All that to say, your company will enjoy working with a neutral, efficient, and specialized court system that understands the ins and outs of corporate law. It means many corporate issues you may encounter will be handled extremely well.
Delaware law is much more flexible
There are very few mandatory requirements that dictate how you set up your governance structure in Delaware, which is preferable for sophisticated parties who want to negotiate a deal and know that it will be enforced.
The lack of rules also supports more flexible corporate statutes when it comes to structuring your corporation and board members. It allows for a more slimmed down corporate structure, one in which just a single individual needs to hold the role of officer, director, and shareholder, rather than 3 or more.
Many other states usually require having a minimum number of three people to hold the officer and director positions.
Needless to say, this means that you should know what you’re doing if and when you’re negotiating the complex set of governance arrangements associated with venture capital financing.
Delaware law does not contain many mandatory provisions designed to protect the oblivious stockholder, meaning it’s more designed for any well-advised stockholders who want the freedom to decide their own terms.
However, the Delaware courts often deal harshly with controlling stockholders who truly abuse their power to decieve minority shareholders. This ensures a larger net of protection against people who overstep.
Additionally, these individuals don’t actually have to be residents of Delaware. Ultimately, this can be beneficial for small and large businesses alike.
There are tax advantages you can leverage
Here we’ll list some of the tax laws in Delaware:
- There is no corporate income tax on services and goods provided by corporations registered in the state that conduct business outside of the state. In other words, if you do business outside of Delaware, but you’re a registered corporation of Delaware, you do not have to pay state corporate income tax.
- There is no state corporate income tax on interest or other passive income.
- No tax royalty payments or other “intangible assets.”
- Stock shares are not taxed by Delaware if their owners reside outside of Delaware.
- Companies with a large amount of authorized stock shares and complex capitalization structures get favorable taxation.
- Non-residents pay no personal income tax.
However, there is a Delaware corporate franchise tax, which is minimal. It is not based on your income, but it does increase as the number of your company’s shares increase, and as your share value goes up.
This corporate franchise tax can be seen as a disadvantage. We will cover its potentially disadvantageous nature in the next section.
Additionally, shareholders who reside outside of Delaware aren’t on the hook for tax on shares, which is why the state is often referred to as a tax haven.
The Disadvantages Incorporating in Delaware
No real tax savings for small businesses
Although Delaware doesn’t tax companies incorporated in the state that don’t do business there, your home state will still tax your company, so you do not avoid taxation.
Paying for a registered agent
When you file, you’ll need to hire a registered agent and provide their name to the state. This person or company, who must be located in Delaware, will accept legal filings on your behalf. If you hire someone to handle this, it will be an additional cost for your business.
Filing is more expensive than other states
This is very simple. When you form a corporation in Delaware, you’ll likely incur filing costs between $1-2K more than in other states. There is also a recurring annual cost for having a registered agent and attorney in Delaware.
You will have to pay registered agent fees to receive any legal correspondence if your business is located outside the state. The charges can range, but typically start around $130 a year.
This fee does not include what you would have to pay a Delaware corporate lawyer, nor does it include other costs you’ll be required to pay when you incorporate, such as first year franchise tax prepayment and other government filings fees.
Paying the annual franchise tax
The Delaware corporate franchise tax is the price you pay for doing business. Not all states require this. Nevada does not charge business owners a franchise tax, making it an inviting alternative.
The amount of annual taxes you pay will be based on the value of your corporate shares. The tax starts at $75, plus a $50 filing fee, and can go higher than $100,000.
Meeting your state’s requirements
Even though you file for incorporation in Delaware, you will still have to meet your state’s filing and licensing requirements for conducting business.
Furthermore, you have to file reports in both Delaware and the states you do business in, meaning extra work and extra expenses.
Consult with a Professional
Is Delaware a good fit? It’s helpful to read up on as much as you can, and we make sure to provide you the most important details. However, delegating the decision to incorporate your company to a business attorney is always encouraged.
Their experience and knowledge will help you make the best decision for your company in the short and long term. Consulting with an accountant is also advised, as taxes play a critical role when starting a business.
Additionally, Delaware Prosperity Partnership, a Delaware-based economic development agency specializing in biotech, science, and technology, covers a number of reasons why Delaware’s STEM-industries are among the strongest in the nation.
- How to Write a Business Plan for Your Startup – Excedr
- Starting an R&D Company? Tips for Founding a Biotech – Excedr
- Business Entities: LLC vs. S-corp vs. C-corp – Excedr
At Excedr, we aim to bring you high-level information regarding the life sciences, healthcare, and the intersection of science and business. However, before making any legal or financial business decisions, you should consult with a professional who can advise you based on your individual situation.