Which state should I incorporate in?

Takeaway: For domestic companies, Delaware is the preferred jurisdiction to incorporate in because of its established corporate legal system, strong protection of directors and officers, and fast processing timelines. International founders may consider other jurisdictions, including the Cayman Islands.

When starting a new business, one of the big early decisions is where to incorporate the company. For companies that expect to raise venture capital financing, choosing the right state of incorporation can have implications for the business and its ability to attract investors. Here are some factors to consider when deciding which state a company expecting to raise venture capital financing should incorporate in.

Delaware

Delaware is the most popular state for companies seeking venture capital financing. This is because Delaware offers several advantages, such as a well-developed legal system, a business-friendly regulatory environment, and a deep pool of legal and financial professionals who are familiar with the state's corporate laws. Delaware's legal system is also known for being flexible and responsive to the needs of businesses. Delaware’s legal system is sophisticated and affords directors and officers of Delaware corporations a high degree of protection. From a logistical perspective, Delaware moves quickly, which can become important when a startup is trying to close a fundraising or acquisition on a tight timeline. I typically recommend that my clients incorporate in Delaware.

California (or the state where the company has its headquarters)

California is another popular state for companies seeking venture capital financing. California is home to Silicon Valley, which is one of the world's most vibrant startup ecosystems. The most common reason cited for incorporating outside of Delaware is that companies do not want to pay the Delaware Franchise Tax. The Delaware Franchise Tax is typically a nominal amount for most companies and, in my opinion, paying the Delaware Franchise Tax is not a sufficient reason to justify incorporating outside of Delaware.

When companies are fundraising, investors will often insist that a non-Delaware company convert to become a Delaware corporation so some companies end up incurring additional legal fees converting to a Delaware corporation as a condition to closing a funding round. Additionally, if a company is contemplating an initial public offering, the underwriters will usually also insist that the company be a Delaware corporation. As a result, it is typically easier to be a Delaware corporation from the start.

Cayman Islands (and other favorable non-US jurisdictions)

While Delaware is the most popular state for startups seeking venture capital financing, some companies (particularly those run by non-US taxpayers) may find it beneficial from an investment or tax perspective to incorporate offshore. For example, companies incorporated in the Cayman Islands, British Virgin Islands, and Bermuda are not subject to taxation in their respective jurisdiction of incorporation. This can permit the corporation to avoid paying US corporate taxes on a portion of its worldwide income.

However, this can be subject to a number of serious tax and intellectual property issues depending on the circumstances. Competent legal and tax advisors should always be consulted prior to incorporation.

Conclusion

In conclusion, when deciding which state a company expecting to raise venture capital financing should incorporate in, it's important to consider several factors, such as the legal and regulatory environment, the availability of resources and talent, and the business's specific needs and circumstances. While Delaware and California are the most popular states for startups seeking venture capital financing, other states may also be attractive depending on the business's needs. It's recommended to consult with a legal and tax professional to determine the best state of incorporation based on the business's specific needs and circumstances.