We are frequently asked whether it would be advantageous for a new company to incorporate in a state other than the one in which it plans to conduct business. Many people believe that there are tax advantages to being incorporated in a given state, or that there are other aspects of a given state's laws that will benefit the company. There are valid reasons for incorporating in other states, but there are a number of misconceptions as well that can lead to additional expenses for entrepreneurs.

As a general rule, small businesses should be legally formed (corporations are "incorporated" and LLCs are "organized", although this memo will use the term "incorporate" to refer generally to both entity types) in the states in which they do business to avoid unnecessary taxes and regulations. As the business grows and seeks financing from outside investors, it may determine at some point that there are benefits to reorganizing itself elsewhere, which can usually be done simply, at insubstantial expense, through a tax-free merger reorganization.

The Tax Myth
Many entrepreneurs believe that incorporating in a state that does not tax domestic entities will mean that their corporations will not need to pay taxes. This is incorrect. Regardless of your state of incorporation, you will be subject to the tax and other laws of each state in which you conduct business.

For example, if you are in Colorado but incorporate your business under the laws of Nevada, you still have to "qualify" your company to do business in Colorado where you are actually located. The cost of qualifying a so-called "foreign" corporation (a corporation formed under the laws of another jurisdiction) to do business in Colorado are the same as the original filing fees for a Colorado corporation. Qualification subjects the corporation to all of the Colorado taxes and other regulations that would apply if you had incorporated under Colorado law in the first place. Further, you will likely be required to pay a corporate agent to represent you in Nevada, if you do not have any other agents or employees in that state, adding another expense to the business each year. Finally, incorporating in Nevada subjects you to the jurisdiction of Nevada courts, which means that you could potentially be forced to travel to Nevada to defend yourself.

Incorporating in Delaware
For companies pursuing funding from venture capital firms ("VCs") or preparing to raise money in public markets, incorporating in Delaware is the common practice, for two primary reasons:

First, the corporate law of the State of Delaware is generally considered to be the most sophisticated, comprehensive and well defined. In particular, the laws regarding fiduciary duties and other matters involving directors are well understood and delineated. For this reason, many Fortune 500 companies are incorporated in Delaware, even though their primary office location is in another state. Additionally, because VCs serve on the board of directors of their portfolio companies, VCs tend to be comfortable with Delaware corporations, regardless of where the VC is based. This makes Delaware a strong choice for companies seeking immediate VC funding.

The second benefit to incorporating in Delaware, as compared with other states, has to do with the legal mechanics of stockholder actions. For example, in Delaware, as in other states, stockholder action can be taken either by having a stockholders meeting at which a quorum of the stockholders vote in person or by proxy, or by circulating what is called a written consent that is signed by the stockholders. It is often preferable to take actions by written consent if possible because stockholder meetings typically require prior written notice of at least 7 days. However, the Delaware laws generally authorize action by written consent with a simple majority of the stockholders' signatures, while many states allow written consents only with the signatures of all of the stockholders. As a result, it is often much easier to obtain stockholder approval if the company is based in Delaware.

Conducting Business Across State Lines
Finally, it should be noted briefly that some companies will be required to qualify in more than one state. Generally, a company conducting isolated, infrequent transactions in a state other than the one of its incorporation will not need to qualify in the foreign state. If the transactions are frequent or regular, on the other hand, the company will need to incur the expenses to qualify in each such state. Failure to do so may mean that the company can be barred from doing business in the foreign state, and that it can be sued in the foreign state, but may not appear in court to defend itself.


About Us

Niesar & Vestal LLC is a San Francisco Business Law Firm with a diverse transactional and litigation practice. Our clients include individuals, emerging businesses, government entities and publicly held companies. 



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