When one of our clients and I talk about forming a new corporation, limited liability company (LLC) or limited partnership, we almost always spend some time discussing the state where the entity will be formed. Usually, we talk about the advantages and disadvantages of forming the entity in the state where the entity will initially do business (usually California), or forming the entity in Delaware. While forming the entity in Delaware doesn’t always make sense, it’s often the best choice for several reasons, including:
- The flexibility of the Delaware statutes governing entity formation and operations. These statutes allow the drafter of the entity’s charter document(s) to choose approaches which make sense for the particular entity. In contrast, some provisions of California law apply regardless of the entity’s charter document(s).
- The well-developed Delaware case law interpreting its laws. Parties may be less likely to pursue litigation relating to a Delaware entity’s governance because the statutes and the case law address most issues that may arise.
- The Delaware Secretary of State is very customer-friendly. The Delaware Secretary of State has long offered expedited filings, and it processes documents very quickly.
- Institutional and other outside investors prefer Delaware corporations. Some investors insist that their portfolio companies be organized in Delaware.
- The Delaware legislature continuously modifies the Delaware statutes to address new developments. The Delaware legislature knows that its state will lose its edge if its law does not evolve to keep up with emerging trends.
- Delaware is a neutral, well-respected jurisdiction. For joint venture and other entities with multiple owners, some of whom may be suspicious of California law and the California courts, Delaware offers the assurance of a well-regarded statutory framework and the prospect that internal disputes will be resolved by a judge in Delaware’s Court of Chancery, which specializes in business disputes, rather than a local trial judge and jury.
The principal disadvantage of forming a Delaware entity is the tax and compliance cost. Delaware corporations must pay an annual Delaware franchise tax, and if they do business in California they must qualify to do business, and pay California franchise tax, as well. Because of these costs, many small businesses whose owners are not concerned about the issues listed above continue to organize their entities in California. There is no single “right answer” to the question of where a new entity should be formed – rather, there are advantages and disadvantages to various states. These advantages and disadvantages should be carefully weighed before a new entity’s state of organization is selected.