Why You Form in Delaware Even If You've Never Been There

The first company we formed, we formed in our home state. The second company we formed, we formed in Delaware at the request of an investor who had not yet committed but who made clear that the request was not negotiable.

We had not understood that an investor's preference about your state of formation was a thing that existed. We formed in Delaware, registered as a foreign entity in our home state to do business there, and paid two annual report fees going forward instead of one. That is the cost of Delaware formation when you operate in a different state.

The question is whether what you get in exchange is worth it.

What Delaware actually provides

Delaware has a Court of Chancery. It is a specialized court that handles business disputes without juries. Chancery Court judges are experienced in corporate law. Decisions are predictable, well-reasoned, and published. A body of case law has accumulated over more than a century that covers nearly every corporate dispute scenario a company might encounter.

For a small business that does not expect litigation and does not plan to raise outside capital, this is an abstraction. The Court of Chancery is unlikely to be relevant to your day-to-day operation, and the specific protections of Delaware's corporate statutes (the ability to limit director liability, the flexibility in designing share classes, the efficiency of merger procedures) are similarly unlikely to matter.

For a company that plans to raise venture capital, these things are not abstractions. Investors have standard documents built around Delaware law. Their counsel knows Delaware law. The term sheet negotiations happen in the context of a legal framework that both sides understand. A company formed in a less familiar jurisdiction creates friction in that process, and sophisticated investors eliminate friction by requiring Delaware formation before they engage.

The mechanics of being a foreign entity

When you form in Delaware and operate in another state, you are a Delaware company doing business in that state. Most states require you to register as a foreign entity to transact business there, which involves a registration fee, a registered agent in Delaware and usually in the operating state, and annual reports in both jurisdictions.

The foreign entity registration is an additional cost and an additional compliance obligation. Annual Delaware franchise taxes are also a factor: Delaware's franchise tax for corporations can be calculated two ways, and the default calculation is unfavorable to companies with many authorized shares. Understanding the Assumed Par Value Capital method before you file your annual report saves money. Many companies overpay because they do not know to ask.

When Delaware does not make sense

Most new businesses are not planning to raise institutional venture capital. Most are service businesses, retail businesses, or professional practices that will never have shareholders other than the founders. For these businesses, Delaware formation adds cost and complexity without adding proportionate benefit.

Form in your home state. The annual report fee is one instead of two. The registered agent is one instead of two. There is no foreign entity registration to maintain. If you later grow to a point where an investor requires Delaware formation, you can redomesticate the company at that time. The conversion process exists. It is not seamless, but it is manageable.

The time to form in Delaware is when you have a specific reason to: an investor who requires it, a plan to go public, or a business structure that specifically benefits from Delaware's statutory flexibility around share classes and governance. Not because Delaware formation sounds more serious. Formation in your home state is fully legitimate, fully enforceable, and appropriate for most businesses.

We formed in Delaware the second time because we had to. If we had been asked beforehand whether it was the right structure for that company, the honest answer would have been: probably not. We raised the money anyway, and the Delaware formation was a fact of that path, not a driver of it.