Where Should I Form My Company?

We get this question a lot, so I wanted to answer it once and for all:

“Should I form my company in Delaware or in my home state?”

The French Philosopher Jean-Paul Sartre once said that you determine the answer to your questions by choosing who to ask. This is one of those cases.

For 40 years I’ve specialized in forming and maintaining Delaware companies and I’ve learned a lot in that time. If I lived anywhere but Delaware, I would never form a company in my home state. In contrast, my company, Harvard Business Services, has formed more than 200,000 Delaware companies in that 40 years.

Why? Because of the sophisticated and balanced corporate laws. New York and many other states are home to the largest companies’ home and satellite offices, but most of them are Delaware companies. If you were forming a local plumbing firm, I would say form it in your home state, but if you’re out to build a business that will be global in nature and scale up to what might now seem like a mighty dream, then Delaware is the only way to go. If you start with a home-state company that’s OK, but you’ll eventually switch to a Delaware company as you become more sophisticated about what corporate power really means.

The Delaware “General Corporation” is an entity specially crafted over two hundred years to be the perfect vehicle to grow into a major force in the world of capitalism. Delaware’s corporate statutes and abundant case law have a clear history of balancing the needs of corporations’ Board of Directors while still remaining fair to the stockholders who invest in the company. Most states have a bias one way or the other and eventually careen off toward that bias; often, this upsets the balance of power in a company and causes its downfall. Delaware, in the wisdom of the Court of Chancery (for which there is no equivalent in any other state) and in the power of a small but dependent legislature, has crafted a long history of supporting the good faith decisions of the board of directors over the selfish interests of the shareholders while still guaranteeing the shareholders the absolute right to their pro-rata share of the dividends.

That’s the crux of the matter in its simplest form, but the recipe that makes it work and has kept it working for 200 years is a beautiful blend of laws passed by the Delaware legislature, mostly at the request of its constituent corporations and corporate attorneys, and the case law that is responsible for interpreting that law to adapt to contemporary business situations. The case law in Delaware, unlike many U.S. states, is decided by a court of business entity law experts that is free of anti-business bias due to the fact that one single judge (Called a Chancellor) will determine each business case brought before it instead of a jury of individuals. The Chancellors in Delaware are chosen from among the state’s top corporate attorneys and they serve 12-year terms. This allows them to make decisions often unpopular but reliably pro-business.

Your company may never need the Court of Chancery to settle disputes between shareholders and the Board of Directors, but you still get the benefit of it because many cases are simply never brought to court, due to the professional predictability. Nevertheless, all Delaware companies benefit from having a large body of case law decided by expert jurists as it provides a roadmap for satisfaction of fiduciary duties, among other things, in a wide range of situations. The predictability created by this copious body of caselaw allows Delaware corporations to plan business strategies, corporate structures, and transactions with confidence. If you do need to pursue an action in court, the process will be expensive but expeditious. Some cases are decided in 24 hours and can only be appealed to the Delaware Supreme Court, which generally provides a great deal of deference to the Chancery out of respect for its experience and knowledge. Also, in many cases, justices of the Delaware Supreme Court are selected from the Chancery Court judges after a term or two with that Court.

Why Choose Delaware Over Your Home State?

1. Delaware’s “Blank Check Preferred Stock” is one big advantage. I’ve written a blog post about that, but, quite simply, it allows the Board of Directors to authorize a separate class of stock that can be divided into separate classes, each of which can have different voting rights (increased or decreased) relative to common stock, dividend rights (often providing a first-priority dividend and/or a special dividend) as well as cumulative rights to those dividends, and security interests (holding the asserts of the company as security for performance), among other tactics to concentrate power in the hands of a few, or direct profits to a preferred class.
2. In a Delaware corporation, a minority shareholder can be forced to sell his stock to the company if a reverse split leaves him or her with a fractional share, provided the Certificate of Incorporation or bylaws prohibit fractional shares. This trick is often used to get rid of a toxic shareholder. If challenged, the directors approving the reverse split and cash out (who usually represent the majority shareholder(s)) must provide a price that is “entirely fair”, the most rigorous standard of review.  The Court may order additional compensation per share if it determines the price does not satisfy this standard.
3. In Delaware, entrepreneurs can take advantage of the Delaware Dynasty Trust, which is not available in most other states and allows for the transfer of management and protection of assets over generations, instead of having to dissolve and break up after the death of a shareholder.

Delaware has and continues to continually innovate, giving entrepreneurs many options for structuring a business to suit their needs. You should have Delaware counsel to advise you on the advantages and disadvantages of different options available, as well as your obligations and potential liability under various business entity forms.  Qualified corporate and business counsel is widely available; such counsel is available in abundance in Delaware, another advantage of incorporating there.

For these reasons, and many more, I would choose (and did choose) to form a company in Delaware rather than any other state. But then, as I said, I am biased.

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