The Top Reasons to Incorporate Your Startup in Delaware

Although IPLawForStartups.com is primarily a legal blog dedicated to intellectual property issues, I’m adding a post today about incorporation because I’ve received numerous questions about the subject.  I asked corporate securities expert, David Bowman to contribute his opinion.

David R. Bowman is a corporate attorney with special expertise in representing startups and technology companies. He is currently the General Counsel for a startup incubator and numerous startups around the world. David has extensive experience in corporate financings, having represented both companies and investors in numerous Angel and VC-led equity and debt financings. He has represented companies and investment banks in initial and follow-on public offerings and has significant public company practice experience.  David also has extensive experience representing both acquirers and sellers in mergers and acquisitions. David has a background in engineering, graduated Cum Laude from the University of Michigan Law School and began his legal career at the Silicon Valley, mega-firm Wilson Sonsini Goodrich & Rosati in 1998.  You can reach David at bowmanlaw [at] me.com.

I asked David the following:  Why should a startup incorporate in Delaware?

In our conversation, David explained specifically why lawyers who want you to incorporate or re-incorporate your startup in Delaware are knowledgeable about the benefits of Delaware procedures and law and want the best for your company.

If you want to create a bright and shiny startup that can grow big, be wildly successful, and get major funding from institutional investors, here are David’s top four reasons for incorporating in Delaware, no matter where your company is located:

1.  Incorporation in Delaware Expedites Funding

Incorporation in Delaware can expedite funding in several ways.

First, incorporation in Delaware is one less reason for venture capitalists to reject your startup for funding.

Most VCs favor Delaware as the state of incorporation because they know the advantages, including but not limited to a well-developed body of law that favors corporations and limits liability for directors. Delaware law provides predictability and reduces uncertainty.  In essence, Delaware corporate law is the state of the art as far as corporate law goes and is the law with which institutional investors are most comfortable.  While venture capitalists will often agree to fund a California corporation located in California, they will generally require a company located anywhere else to be incorporated in Delaware before they will invest.  Incorporating in Delaware shows that you know what you are doing and understand the preferences of your potential investors.

Second, incorporation in Delaware can literally expedite getting your money in a funding round or from a merger or acquisition.

The Delaware Secretary of State’s Office has made customer service a priority.  Filings are streamlined and electronic and you may expedite receiving acceptance of the filing back from the state to as little as one hour after filing.  If you opt for this or the two hour expedited service, Delaware will guarantee your receipt of evidence of acceptance within that time. Some other states, including California, will offer up to a 48 hour expedited service, but often will not guarantee even this lengthy turnaround time.  If there is a backlog, you will get it when you get it, even if you expedite.

Quick turnaround times for corporate filings are critical when you need to close a deal quickly.  For example, if you are raising money in a preferred stock financing, you must file an amended certificate of incorporation with the state of the company’s incorporation and receive a certified copy of the filed document, which is evidence of the filing’s effectiveness, before you can sell the preferred stock and close the deal.  Because the certificate of incorporation includes the terms of the preferred stock being sold in the financing, it is often one of the last documents to be finalized.  Once the parties have finished negotiating and finalize the documents, you must still wait to close until the amended certificate of incorporation has been filed and evidence of acceptance has been returned even though the deal has been struck and the investors are ready to fund.  In Delaware, that wait can be as little as an hour.  This can be a critical advantage where there is a hard deadline or a looming payroll.

Delaware also makes corporate filings for M&A deals easy and quick.  Once the hard work of negotiating the merger agreement and getting it approved has been done, you only need to file a simple one-page Certificate of Merger with Delaware in order to make the merger effective.  The Certificate of Merger states some basic information about the merger – among other things, the names of the corporations being merged, the name of the surviving corporation, and a statement that the parties have approved the merger and related merger agreement – but does not include the economic terms of the merger.

Compare the Delaware process with California, where you must file an “agreement of merger” in which the key terms of the merger, including price, are summarized.  So not only do you have to summarize the terms of the merger in a publicly available filing, you have to pay for your lawyers’ time to create a condensed version of the main merger agreement.  Then you must wait at least 48 hours, since that is the fastest expedite time in California.  If the examiner at the state does not think the agreement of merger summarizes enough of the key terms, they can reject it and require changes.  If this happens, you have to refile and start your wait for evidence once again.

In short, incorporating in Delaware will facilitate investment while incorporating in other states can hinder investment, either because institutional investors won’t invest in anything but a Delaware corporation and either pass or require you to reincorporate in Delaware due to the more cumbersome filing processes of other states. 

2.  Delaware Has Answers to Corporate Problems

Delaware has a highly developed body of law, including a sophisticated business statute and extensive case law that has interpreted almost every section of the statute.  In the early 1900s, Delaware made a conscious decision to be the premier state for business law.  To that end, the Delaware state legislature created very flexible, business friendly laws.  The Delaware legislature responds quickly to amend corporate laws to counteract unexpected problems and Delaware’s Court of Chancery is expert in corporate law and in resolving corporate law problems and issues.  The result of the state’s effort is that Delaware is the state of the art for corporate law and has become a standard with which lawyers practicing in all states must be familiar.

Lawyers can rely on the certainty, stability, and predictability of Delaware law and work around common business issues.  In other words, the boundary lines for what can and cannot be done are clearly set in many areas of Delaware law, so your lawyers will find it more efficient to structure transactions and formations and advise you as to the propriety or risk associated with various corporate actions and issues if your company is a Delaware company.  In contrast, many states have significant areas of legal uncertainty where the statute is ambiguous or has never been interpreted by the courts.  Uncertainty can be very expensive when you have to litigate in court to get an answer or where a buyer perceives risk as a result and lowers the price paid for your stock or to acquire your company.

Delaware’s extensive statutory and case law provide the most developed and most widely used and accepted body of business law in the country.  Plugging your company into that body of law and taking advantage of the certainty it brings will save your company time and money over the course of the company life cycle.

3.  Delaware Is the Best Forum For Business Litigation

If you do find yourself in litigation on a corporate law matter, Delaware’s Court of Chancery is, without question, the most sophisticated and expert court in the country with regard to corporate law disputes.  Decisions are made by highly experienced judges who are experts in corporate law rather than by uninformed juries.  Because the Court of Chancery only adjudicates business disputes, cases are litigated quickly and efficiently by judges who are experts in corporate law and corporate legal problems.

4.  Incorporation in Delaware Will Reduce Your Legal Bills

Contrary to some beliefs, incorporation in Delaware can actually reduce your legal bills.  Expert startup lawyers, including corporate lawyers in big Silicon Valley law firms, incorporate companies in Delaware if they plan to seek significant funding from institutional investors like venture capital funds.  Consequently, almost all of their clients will be incorporated in Delaware and they will be experts in Delaware law.  All corporate lawyers know Delaware law because it is taught in all of the law schools, but lawyers who focus on representing startup companies and venture capital funds will have particular expertise in Delaware law as well as a large library of corporate documents that were drafted based on Delaware law.  When your company incorporates in Delaware, you make it easy for your lawyers to be efficient because they know Delaware law and have Delaware law forms for nearly every type of business formation or transaction.  As a result, they don’t need to reinvent the wheel just for your deal and you don’t need to pay them to do so.

Lawyers make far more money if you are incorporated in a random state because they will bill you more money for the additional time it takes to research the law, try to find answers, draft in legal darkness, and customize their forms to that state’s law.

As mentioned above, the fact that Delaware law is well developed means that there are fewer areas of ambiguity and uncertainty for your lawyers to research and work through and less risk of litigation down the road.  And if you do end up litigating a corporate law issue in Delaware, the Court of Chancery will be an efficient forum in which to resolve the issue.  Both of these factors can help you save money on legal fees.

In summary, if you plan to raise capital from venture capital funds or sophisticated angel investors, incorporating in Delaware will save you time, expense, uncertainty and will show that you understand how things work in the world of startups and startup investing.

Jill Hubbard Bowman is an attorney who specializes in helping startups.  She can be reached at hubbardbowman [at] me.com.