Which state should you form your business in?
This is one of the first decisions a startup has to make. Like many startups, you might be considering Delaware, even if you won’t be doing any business there. Delaware is definitely a popular choice for startups, but is it really the best state for your business?
For many small businesses, especially those in other states, Delaware is not the best option.
I know, that goes against so much of what you’ve heard. Many businesses (and lawyers!) fall into the trap of thinking Delaware is the absolute best state for businesses. Delaware has become such a common choice for starting a business that most people never question the advantages and disadvantages. Let’s break down the myths that often convince businesses to register in Delaware. We’ll also cover when Delaware could be right for you.
Myth #1: It’s cheaper to start your business in Delaware.
Sure, Delaware’s filing and maintenance costs are on the cheaper end. But here’s the thing: if Delaware isn't your home state, that fact has legit consequences. If you register in a state outside of where you do business, you still have to register as a “foreign entity” in your home state, which means additional filing fees. You'll also have to pay taxes in both states (annual franchise tax in Delaware and income and other business taxes in your home state). Plus, you'll have to pay for a registered agent in Delaware. All of this can be very time-consuming, and it ends up costing you a lot more than what you originally thought.
Let’s crunch the numbers real quick. Say you have an LLC in Missouri and are considering to register in Delaware. Your options have the following costs:
Option 1: Costs for Registering in Missouri
- Articles of Organization in Missouri: $50 (which can be prepared and paid for online, otherwise it is $105 to print out and mail)
- Missouri State Taxes (varies)
- Total: $50+
Option 2: Costs for Registering in Delaware
- Certificate of Formation in Delaware: $90 (which can’t be completed online and must be mailed or faxed)
- Certificate of Good Standing: $50 (this is required to file as a “foreign entity” in another state)
- Delaware’s annual LLC franchise tax: $300
- Application for Registration of Foreign Limited Liability Company in Missouri: $105
- Missouri State Taxes (varies)
- Registered Agent: around $45 on the lower end
- Total: $590+
As you can see, Missouri LLCs will have to spend at least an additional $540 if they decide to form in Delaware instead of Missouri, not to mention the extra paperwork that is involved. But for some startups, these additional fees and paperwork may not outweigh the benefits of forming in Delaware.
Myth #2: Delaware has no income tax, which is great for your business.
You might have heard that Delaware has no income tax. That's true. But if your business is located outside Delaware, the state’s zero income tax will probably not mean anything to you.
Income taxes are due in states where the income is earned, not where the company is registered. To illustrate this point, let’s say you have a corporation located in Missouri. All of the business is conducted in Missouri, but it’s incorporated in Delaware. In this case, all of your income is subject to Missouri’s corporate income tax (at a tax rate of 6.25%). You don’t owe any Delaware income tax, but this has nothing to do with the zero income tax. Instead, you don’t owe Delaware taxes because your business didn’t earn any income in Delaware.
Myth #3: Delaware law will better protect your business in case of a lawsuit.
"Since Delaware law is so business friendly, you should form your business there." We've heard that one before. But that kind of logic doesn't make sense in the legal world.
Let's say your business commits some type of wrong (hypothetically, of course). If that happens, the law applies from the state where the wrong happened, not where the business is registered. Delaware law would only apply in these cases:
- if a contract at issue specifically stated that Delaware law would apply,
- if there is an internal shareholder dispute within a company that is registered in Delaware, or
- if some kind of a wrong occurred in Delaware.
So just because your business is registered in Delaware does little to guarantee that Delaware law will protect you in court.
And another thing.
In Delaware, if a shareholder sues the company, larger companies get strong protections over shareholders. But this doesn’t apply for most smaller businesses.
Keep in mind that lots of businesses are “single-member limited liability companies,” which means that the whole entity has only one member. If the business consists of just one person, you don’t have to worry about that one person suing the company.
But don’t rule out Delaware just yet!
There are some scenarios where registering in Delaware makes sense.
- Delaware is your business’s home state, or your business will do business in Delaware as well as other states. In this case, then those concerns about registering in multiple states no longer apply.
- You want investors early on. Plan on hitting up incubator programs and pitch competitions to prepare for early stage funding? Most investors love Delaware, so setting up in Delaware will let potential investors know you’re serious. There's a variety of reasons why investors prefer Delaware. But the main point here is that you want to please your investors. So just go with Delaware.
- You plan on being a unicorn. Do you have legitimate goals of getting that billion dollar valuation and going public? We’re talking about more than wishful thinking here. If you do, set up your business in Delaware and don’t even blink an eye. Delaware is the place to be to go public. Good for you! Dream big, my friend.
You might be thinking, “I’m not doing business in Delaware, but I might like to have investors down the road.”
Many startups are in this boat. There’s an easy solution here. Register in your home state. If an investment opportunity comes around, you can change to Delaware if the investors insist on it. There are a few ways to convert your home state company to a Delaware company. When that time comes, you and your investors (and attorneys and accountants) can discuss what’s best for your situation.
Don’t get hung up on this.
We can’t recommend this enough: do not lose sleep over this decision. Keep it simple. When deciding where to form your business, just remember: “There’s no place like home.”
Have any thoughts or experiences on choosing where to form your business? We’d love to hear from you. Share your opinions and stories below.