Why Incorporate in Delaware? Pros and Cons for Startups

What state is home to over two-thirds of Fortune 500 companies, half of US publicly traded companies, and the beachside amusement park Funland? The answer, of course, is Delaware.

While Delaware’s corporate law is famously friendly to large public corporations, banks, and credit card companies, incorporating in Delaware can also be a good choice for small or early-stage businesses—particularly those that plan to seek investor funding.

As a result, most startups also choose to incorporate in Delaware. In 2021, over 90% of all initial public offerings in the US were registered in the state.

Why incorporate in Delaware?

Incorporating your business in Delaware is fast, relatively affordable, and can confer a set of legal and tax advantages for all types of business entities. Services like Stripe Atlas can even set up a Delaware business for you in just a few days.

Some entity types can also gain additional advantages. LLCs and corporations can benefit from investor preference for businesses incorporated in the state, and C-corps and other corporations can take advantage of flexible corporate laws regarding stock distribution and transfer.

Here’s an overview of each major benefit of choosing Delaware to incorporate your business.

Liability protection

Delaware business law provides strong legal and liability protection for business owners, typically requiring evidence of corporate fraud to overturn protections. In fact, the Institute for Legal Reform’s State Liability Systems Ranking Study regularly finds that attorneys and executives with corporate litigation experience rank Delaware’s liability protection as the best offered by any state in the US.

Corporation court

Delaware’s Court of Chancery is a non-jury court that only handles disputes involving Delaware business entities. Decisions are made by judges who specialize in corporate law, making Chancery Court proceedings efficient and decisions more predictable than those made by other courts in similar corporation cases. Because so many companies are incorporated in Delaware, corporate attorneys outside of the state also tend to be familiar with Delaware law, which can further increase the efficiency of any legal proceedings.

Investor preference

Delaware corporation laws are more flexible than those in most other states. As an example, Delaware C-corps can continuously issue more shares of stock, issue multiple classes of stock, distribute stock options to employees, and more easily transfer shares of stock than corporations formed in other states can. For these reasons, venture capital firms, investment bankers, and angel investors prefer Delaware corporations.

Efficiency

Delaware prides itself on offering a quick and simple business set-up, including same-day processing of business filings. Delaware also allows one person to hold multiple corporate roles such as officer, director, and shareholder.

Tax benefits

Delaware also doesn’t have sales tax or investment income taxes, and companies incorporated in Delaware don’t need to pay state corporate income tax unless they also do business there. Delaware also recognizes S corporations as pass-through entities, meaning that the state doesn’t tax S-corps at the entity level. The only tax that Delaware businesses always pay is franchise tax, which is assessed based on the total value of a company’s shares. Talk to your CPA to understand your tax obligation in Delaware.

Drawbacks to incorporating in Delaware

Although there are many benefits to incorporating in Delaware, it’s not always the best choice for all businesses. Here’s a rundown of the main drawbacks.

Cost

All businesses formed in Delaware owe franchise taxes to the state, regardless of whether or not they do business there. Unless you have a physical address in Delaware, you’ll also need to obtain a registered agent in the state to form your business there, which carries an additional cost. If you plan to do business in states other than Delaware, you’ll also need to foreign qualify in those states and pay associated fees. Depending on your business activities, it may be more cost-effective to form your business in your headquartered state or in a state where you plan to do business.

Reporting requirements

If you incorporate in Delaware, you’ll be required to file an annual report in Delaware, your headquartered state, and potentially also in other states where you conduct business. Duplicate reporting obligations require businesses to invest more time and money to stay compliant.

Minimal tax savings for some businesses

Incorporating in Delaware can confer massive tax advantages—or not. It depends on your business entity type, where you earn income, and whether or not your company is large enough to invest in the accounting and business strategy methods required to take advantage of the state’s corporate income tax advantages.

If you don’t do any business in Delaware or operate an entity not otherwise subject to corporate income tax (such as an LLC or an S-corp), Delaware’s corporate income tax policies won’t benefit you—and you’ll still owe franchise tax there.

How to decide if incorporating in Delaware is right for you

Whether or not you should incorporate in Delaware depends on your business structure, operations, size, and goals. Here are a few things to consider when making the choice.

Do you conduct business in Delaware? If you conduct business in Delaware, incorporating in the state can eliminate one of your potential foreign qualification needs. You’ll also benefit from the state’s lack of state corporate income tax.
What are your liability concerns? Incorporating in Delaware isn’t the only way to obtain liability protection—incorporating in any state can protect your personal assets, and liability insurance can offer protections for your business. That said, Delaware’s business-friendly policies (and business-only court) are generally considered to provide stronger liability shields to companies than other states can offer.
What is your entity type? Some of the benefits of incorporating in Delaware apply to all business types, such as liability protection, legal process in the Court of Chancery, and quick registration. Investor preference, flexible regulations around stock distribution, and the lack of state corporate income taxes are mainly beneficial to corporations.
Do you plan to seek investor funding? If you plan to seek investor funding, it’s a good idea to make your company as attractive to potential investors as possible. Investors generally favor Delaware corporations in investment decisions.
What are your revenue goals? Large corporations tend to have larger accounting budgets—if your annual revenue is in the billions, it can be cost-effective to invest in accounting strategies that allow you to declare some income earned in other states in Delaware. If your annual revenue isn’t yet in the billions—but you have ambitions to get there—you might incorporate in Delaware for the flexibility to adopt these strategies at a later date.

If your business is incorporated in Delaware, Mosey’s compliance platform can help you navigate legal, tax, HR, and insurance requirements across all states you do business in. Mosey supports corporations with large teams and provides guided steps for new founders to help navigate the business compliance needs after incorporation, including foreign qualification in your headquartered state, getting your founding team on payroll, and managing ongoing compliance.