I am often asked where one should incorporate their business, for which there are generally three answers: 1) Delaware; 2) your home state (Texas, California, etc.); or 3) off shore (Caymans, BVI, Bermuda). The choice you make depends on your individual business, your investor preferences, and where your customers and investors reside.

Delaware

Delaware is often chosen for many reasons, including: 1) insistence of investors and underwriters; 2) established and efficient corporate law and court system; and 3) favorable protections for directors and officers. These are discussed in more detail below.

If you plan on raising money from venture capitalists, private equity groups, institutional investors, or other sophisticated investors you should definitely choose Delaware. Often times these investors will force you to convert into a Delaware company before they invest, so you might as well do it in the beginning and save the added time and money of having to convert at a later date when it might hold up a financing. Also, if you might someday take the company public, the underwriter will most likely force you to convert into a Delaware entity prior to the public offering. If either of these is a possibility for your company, choose Delaware and do it right the first time.

Investors and underwriters insist on Delaware because it has a very favorable corporate law system. It is the home of 60% of Fortune 500 companies and 50% of publicly traded companies for a reason. Delaware courts have extensive experience in corporate law due to specialty courts designed to only handle corporate law issues. This is turn leads to a highly developed body of corporate case law that provides corporations and their counsel with excellent guidance and more certainty on matters of internal governance and liability. In short, corporations and investors know exactly what they are getting into with a Delaware corporation, and this added certainty makes it easier to do business for everyone involved.

Also, officers and directors of Delaware corporations are afforded a great deal of protection when it comes to making business decisions. Absent fraud or self-dealing, the courts will generally protect the good-faith business judgment of the decision maker, which makes it less likely that they will be sued by shareholders who don’t agree with their decisions. And if they are sued, the corporation can compensate them for any losses incurred in the defense. This makes it easier for the lawyers to advise directors and officers on their fiduciary duties in a Delaware corporation.

There are two drawbacks to incorporating in Delaware: 1) you must register as a foreign entity to do business in your home state; and 2) you must pay Delaware franchise tax in addition to your home state corporate income tax and/or franchise tax. Registering as a foreign entity in your home state usually incurs additional legal and filing fees (in Texas you can expect an additional $1000 or so, $750 of which is filing fees). Delaware has no state corporate income tax, but they do have a franchise tax. During the first years of a company with limited assets and few shareholders, the franchise tax is usually negligible and can be calculated using the Franchise Tax Calculator provided by the state of Delaware.

Home State

If you do not plan on raising money from venture capitalists or private equity groups, don’t plan on taking the company public, want to avoid the added expense of foreign registration in your home state, and want to avoid paying Delaware franchise taxes, then you should probably incorporate in your home state unless a large portion of your revenue will be coming from off-shore activities.

Off-shore

There are generally two reasons for incorporating off-shore: 1) some foreign investors are prohibited from investing in U.S. companies; and 2) tax savings on income received from abroad. If you do significant amount of off-shore business you should consider incorporating off-shore to minimize paying U.S. corporate tax on off-shore income. This is an extremely complicated matter of law, beyond the scope of this article, and should not be undertaken without specialized tax and legal counsel.