Choice of State for a New Corporation

I recently did a blog about California clients wanting to form LLCs outside of California in order to avoid California franchise taxes, and how the Franchise Tax Board has been steadily trying to eliminate those possibilities. In response to that blog, I was asked about other non-tax considerations for choosing a state for the formation of a business. So, here is a brief analysis of some of the things I consider when helping my clients choose the right jurisdiction for their new corporation.

When a client comes into my office in San Jose and asks about forming a business entity outside of California, the most common jurisdictions they are considering are either Delaware or Nevada. Delaware has traditionally been the favorite jurisdiction, and Nevada is gaining in popularity.

Why incorporate in Delaware?

• Delaware is a leader in making incorporating easy for founders, including accepting Certificates of Incorporation by e-mail and fax and without signatures, providing for expedited filings in one hour, and allowing Boards to hold meetings electronically.
• Delaware’s corporate laws allow for limitations on personal liability and indemnification of the officers.
• Delaware law is well established and it has a special court, the Court of Chancery, to deal solely with corporate matters.
• Venture Capitalists are familiar with Delaware and their forms are based on Delaware law.
• A majority of companies on the NYSE are incorporated in Delaware.

• A majority of Fortune 500 companies are incorporated in Delaware.

Why incorporate in Nevada?

• Nevada does not have a franchise tax and it does not tax corporations for income earned in Nevada. (Of course, this does not get a company out of California franchise and income taxes if it is doing business in California, but a lot of people don’t realize that.)
• Nevada caters to smaller, private companies.

• Protection for corporate management is very strong. Directors and officers are not compared to an objective standard of behavior, making it harder for them to be held personally liable for acts that may have otherwise been determined to not be in the best interest of the company.

Why (or why not) incorporate in California?

• For companies doing business in California, California usually makes the most sense as a jurisdiction since California law often applies to foreign entities anyway if they are doing business here.
• Franchise taxes are high in California, but forming outside of California will not exempt a business from California franchise taxes if it has a presence here.
• California does allow telephonic and electronic meetings of the board of directors.
• The California Secretary of State, despite usually long waits for filings, does have expedited filings for a fee.

• California corporate laws often protect shareholders over management – such as requiring shareholder approval for loans to officers or directors and providing for cumulative voting rights.

Of course, these choices are also impacted by the business of the company and its strategic plan for the future. In addition, choice of state is only one of many informed decisions that must be made by the founders, their business lawyer, and their CPA before jumping into the formation of a new company.