Delaware has a reputation for being one of the most business-friendly states to incorporate. Many of Delaware’s corporation laws and statutes are used as a model for business laws in other states. Over half of all the publicly traded companies in the United States, 65% of Fortune 500 companies, and many startups are incorporated in Delaware. While large companies see many benefits of incorporating in Delaware, those benefits may not apply to small businesses. Below is a discussion of the advantages and disadvantages new business owners should consider when contemplating where to incorporate their organization.
Franchise Taxes
One of the most attractive reasons to incorporate in Delaware is its favorable tax treatment. Generally, businesses incorporated in Delaware do not usually do business within the state. As a result, corporations do not pay Delaware corporate income taxes. Delaware also does not have a sales tax, investment income tax, or personal property taxes. Companies must pay a franchise tax if they wish to register in Delaware, but this is typically inexpensive compared to the costs other states would charge for their income tax.
While this benefits large companies, there may be minimum tax savings for small businesses. Not only must a corporation register with Delaware and the state where they wish to do business, but they will likely have to pay a franchise tax in both states. For example, Article 9-A of New York’s Franchise Tax on Business Corporations Law requires foreign corporations to file and pay the state’s franchise tax. This doubles the organization’s tax bill for companies incorporated in Delaware but headquartered in New York. While this tax in Delaware is initially minimal for small business, the more the company’s shares and share value grows, the more the tax will increase.
Annual Tax Reports
On top of a double franchise tax, the business will also have to file annual tax reports with Delaware and the state in which they do business. One business pays two separate fees to file their annual tax reports. This additional paperwork can result in increased tax preparation fees as well.
Investor Preference
Institutional investors or angel investors typically prefer or even require that businesses be incorporated in Delaware. Delaware makes attracting investors easy for startup businesses seeking to obtain venture capital due to their corporate-friendly and flexible statutes. However, small businesses that do not plan on becoming publicly traded or raising large-scale investments will not benefit from Delaware’s investor-friendly laws since they will most likely not plan on issuing multiple classes of stock or creating complex shareholder agreements.
Court Proceedings
Delaware’s sophisticated Court of Chancery (Court) will likely hear disputes when legal issues arise for a business. This Court is renowned for its judges specializing in corporate law and its established and predictable legal precedent. Unlike the traditional civil lawsuit, cases brought to Delaware’s Court can be resolved quickly.
While this is good news for large corporations who can afford the costs of an expeditious but complex court proceeding, smaller businesses may have to endure unnecessary fees and expenses. By incorporating in Delaware, companies are presumed to have consented to the jurisdiction of the state’s Courts. This means organizations that do business in another state and become involved in a legal conflict will likely have to resolve that dispute in Delaware. Although these Courts are known for their legal expertise and unbiased judges, a business owner may have to retain a Delaware attorney with comprehensive knowledge of the state’s business laws. If the conflict requires appearances in court, this is not only an additional costly burden that requires back-and-forth travel but can also be time-consuming.
Takeaway
Delaware is widely regarded as business-friendly due to its favorable tax laws, investor appeal, and efficient legal system, making it ideal for large companies. Before deciding to register in Delaware, potential new business owners are urged to consider whether Delaware’s laws will act as an advantage to their organization or if it will result in unnecessary and avoidable expenses. Most small businesses planning to be locally focused and self-funded will not see significant tax savings and other benefits that a large corporation may experience. At Halpern and Scrom, we are prepared to offer our expert legal advice to assist a business owner in determining whether they will reap the benefits of incorporating in Delaware.
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