WHERE TO INCORPORATE YOUR SMALL BUSINESS

Introduction

Many California business owners have heard and read that Delaware is the best state in which to form their entity due to their business-favorable laws. In particular, Delaware has historically offered:

• the most favorable franchise tax rules and been the most pro-management from a legislative and judicial perspective;

• broader protection for board members against derivative suits (lawsuits initiated by shareholders on behalf of the corporation);

• less legal protection for minority shareholders than California (e.g., cumulative voting is not required and staggered boards are allowed); and,

• limited statutory protection against hostile takeovers.

However, despite the ease and potentially favorable factors that point to Delaware as a destination for business formation and incorporation, there are some factors that California business owners, especially those who own small businesses, should consider before jumping on the Delaware bandwagon.

Cost Comparison Between California and Delaware

It currently costs $89 to file articles of incorporation in Delaware. The required annual report filing fee for all non-exempt domestic corporations is $50, plus taxes. The minimum Delaware corporation tax is $175 for corporations using the Authorized Shares method, and a minimum tax of $350 for corporations using the Assumed Par Value Capital method.

In contrast, the fee for filing articles of incorporation in California is $100. There is also a requirement to file an initial report within 90 days of incorporation which provides detailed information about your company and includes a fee of $25. In addition, the state requires the filing of an annual report along with a filing fee of $25. Most corporations will also pay a minimum annual franchise tax of $800 to the California Franchise Tax Board.

LLCs in Delaware are a little different. LLCs are $90 to form and are not required to file an annual report. However, they are required to pay an annual tax of $300.

LLCs in California do pay less than corporations in most cases. The formation fee is $85 and the 90 day Statement of Information fee is $20. Unlike California corporations, LLC’s must file a report with the state every other year rather than every year, along with a fee of $20. And the annual minimum tax payable to the Franchise Tax Board remains at $800.

While it may appear, from the outset, that Delaware is the preferable place to form your business based on a cost analysis, if your company does business in or from California, it must be registered in California whether it was formed in another state or not. This means that companies who conduct any business in or from California will remain subject to the filing fees charged by the California Secretary of State’s office, and must pay the minimum franchise tax of $800. Furthermore, a Delaware corporation operating in California must maintain a registered agent in Delaware (in addition to having one in California), which generally costs a minimum of $100 per year.

As you can see, if your company does business in or from California, incorporating in Delaware substantially increases the costs of formation and annual reporting. Click on the following links for the Secretary of State’s office of California and Delaware, respectively https://www.sos.ca.gov/business-programs/business-entities/ and https://corp.delaware.gov/.

Corporate Laws

The corporate laws of Delaware are very well developed and, as mentioned previously, business friendly, especially for businesses that have a national customer base and also for venture capitalists. However, it is important to consider how your business will be structured before determining the optimal state in which to incorporate. For example, if your business is structured as a single-member LLC, the business-friendly laws of Delaware are unlikely to be of any benefit to your business.

Other factors to consider are your business goals, where you will conduct business, and where you will bank. If you plan to bank and do the lion’s share of your business in California, then the decision is usually fairly straightforward, you would be better off ,in most cases, to incorporate in California. And, as previously discussed, if your business will generate California source revenue, or is operated from California, it must be registered in California.

If a California based business is incorporated in Delaware, lawsuits against the business may be filed and litigated in Delaware. While the outcome of such lawsuits could potentially be more favorable in a Delaware court, there is no guarantee that will occur. And, if your business is located outside of California, litigating a lawsuit in Delaware obviously becomes more expensive and inconvenient for a California based business owner since there will be significant costs associated with that scenario, like traveling to and from Delaware. As a result, you may incur extensive expense without any real benefit.

The good news, and another reason to choose the California versus Delaware option for forming your business, is that California has now incorporated a large portion of the Delaware General Corporations Law into its statutes and regulations thereby bringing many of the benefits of filing in Delaware to California.

Conclusion

With some exceptions, large corporations, not small or medium-sized businesses operating in California, will typically benefit from incorporating in Delaware or another state outside of California. When you are considering the type of business entity or structure to utilize for your business, or the most favorable state in which to incorporate, contact our trusted Business and Corporate Attorneys at the Gehres Law Group for a complimentary consultation. We’re confident that you’ll be glad you did.

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