August 15, 2013
Most entrepreneurs and small business owners have heard about incorporating in Delaware. According to the N.Y. Times, more than half of all publicly traded companies are incorporated in Delaware. Why do so many other businesses incorporate outside their home states and should you do it too? What does everyone know that they don’t?
There is a new start-up, Founder Set, that’s here to answer these very questions. FounderSet was founded by a startup attorney veteran and is an online legal service. FounderSet provides a complete Delaware incorporation package for startup companies. FounderSet is based in the Silicon Valley and aspires to allow entrepreneurs anywhere to have access to veteran Silicon Valley startup attorneys.
Cynthia: Why incorporate in Delaware versus your home state? What are the advantages?
FounderSet: Since almost all venture capital backed companies are incorporated in Delaware, all the legal forms, templates and investment transaction documents are tailored to DE law and they have been used in the industry for years. If you incorporate in any other state, that may delay the investment process significantly as it may require a specific legal review for these state laws. An investor may also require you to change the state of incorporation and that could result in further delay and more legal fees.
Cynthia: Most new businesses don’t have professional investors such as VCs, angels, or syndicates involved. Most get started without investors at the beginning, should these entrerpeneurs consider incorporating in Delaware and why?
FounderSet: Even if they do not have investors lined up in day one, when that happens, they will need to be ready. Moving your parent corporation into a different state could be a complicated process on some occasions, especially if your company is up and running for several years. If you ever see VC financing in your future, DE is much preferred. This Includes if you’re planning to be purchased since M&A transactions for startups are also done with Delaware companies in most cases.
Cynthia: If a small business is up and running, maybe as a LLC or S-corporation or other alternative entity, when should such a small business consider moving to a C-corporate status as a Delaware company?
FounderSet: Although it is legally possible to convert these entities into a Delaware C-corporation, these things may get complicated and may involve substantial legal fees. If the startup is still owned by the same founders and not a lot had happened in terms of business and contracts, then that should be a relatively straight forward process (though it would require an attorney). However if the LLC has several investors and other interest holders, entered into contracts and has more activities in the company, that could be a painful process which could even be blocked by an interest holder in some cases, not to mention hefty legal fees. If your start up is geared to raise VC or angel financing, we believe it makes a lot more sense to incorporate as a DE C-corp.
Cynthia: Other services can incorporate a startup and act as a registered agent for a much less cost than FounderSet? Why should an entrepreneur choose FounderSet instead of the others?
FounderSet: Other online incorporation services offer basically the incorporation part only; they only help set up an entity. That’s the easy part. In startup incorporation, the set up legal documents are the distinctive feature. One of the key agreements founders needs to execute during the incorporation phase is the Founder Restricted Stock Purchase Agreement which basically provided for founders vesting. Founder vesting is key not just a basic requirement by any investor but also is important for the relationship of founders between themselves (to avoid a difficult situation where one founder leaves and walk away with 50% of the company). The set up documents also include a founders’ technology assignment agreement that is key to any startup looking to maintain the integrity of its intellectual property. FounderSet also offers other VC grade standard documents such as initial board resolution, where you nominate officers, bank account, stock allocation and so on. These key set-up documents are only offered by law firms these days. FounderSet is run and operated by startup veteran attorneys and offers that to entrepreneurs at a fraction of the cost and with instant access on-line.
Advantages and Disadvantages of Incorporating in Delaware
- Delaware allows flexibility in conducting business without specifying a code of conduct, whereas, other states try to regulate every detail of corporate behavior.
- Delaware’s statutes offer the best protection for board members and directors permitting companies to limit the liability of directors in corporate charter and offering companies the ability to indemnify directors, officers, and employees.
- There is predictability of legal outcomes. As Chief Justice William Rehnquist pointed out, “Outside the takeover process, most Delaware corporations do not find themselves in litigation … The Court of Chancery has handed down opinions interpreting virtually every provision of the of Delaware’s corporate law statute. No other state court can make such a claim. “ Delaware handles litigation quickly and effectively.
- Delaware allows complicated mergers to be done with ease. This could be handy in transactions where speed is necessary relating to financing or contracts.
- Delaware corporate law is viewed as the closest to a body of national corporate law. It is commonly viewed as the premier set of standards, and can act as branding for a company. As such, professional investors prefer companies to be incorporated in Delaware since it provides a familiar base of understanding for them.
- Filing fees in Delaware are more expensive than many other states. These filing fees are in addition to the filing fees you will then need to pay to register your corporation in the state in which your company is actually conducting business. Thus, you have to maintain two state registrations.
While these issues are important, they are for large corporations and mean very little before a company is ready for an IPO or rounds of equity financing. As a general rule, when founders are not contemplating a venture-backed business, attorneys usually don’t recommend a Delaware incorporation.
Filed under: From Concept to Start-Up