What’s in a State: Choosing where to Incorporate your New Business

By Amy Riedel

We have previously discussed how some founders might choose their business structure (here and here) and what organizational documents are necessary for formation depending on entity structure. Once you have decided on what type of entity you want to form, the next question becomes where you want to form it. For many for-profit businesses, this means incorporating in your home state. Some states, however, offer certain advantages for businesses that encourage incorporation even though the business may not be physically located in that state.   As explained below, the key consideration becomes whether the added cost is worth the advantages of out-of-state incorporation.

 

The Advantages of Out-of-State Incorporation: Delaware.

The most popular of these states is Delaware. Delaware has a long history of favoring business interests. Its corporate code allows corporations and shareholders flexible business management. In fact, the statute is often copied by other jurisdictions. Delaware also has the “Chancery Court,” which is a court that only hears business issues. The Chancery court’s judges can therefore focus exclusively on business issues, which means that Delaware’s extensive Chancery Court case law provides corporations (and their counsel) with well formed guidance on business issues such as corporate governance and officer/director liability.  Like its corporate statutes, Delaware case law is highly persuasive, many foreign state courts rely on that case law for business matters.

For the above reasons, public companies in particular chose to incorporate in Delaware. More than 50% of all publicly traded U.S. companies incorporate in Delaware, including 64% of the Fortune 500.[1] This means that incorporation in Delaware carries a certain cachet and for some companies, particularly those planning on seeking venture capital financing, incorporation in Delaware is a necessity.

Delaware also offers more privacy than some states. Unlike Washington State, it does not have a publically available list of the officers and directors of the corporation. But it is important to note that any details included in the Articles of Incorporation or other filings can be requested as a public record, so this privacy is limited. If you form a limited liability company, further anonymity can be provided if the members and managers are simply other business entities.

 

The Advantages of Out-of-State Incorporation: Nevada and Wyoming. 

Moving to the “wild west,” Nevada and Wyoming have both gained popularity in recent years. Both offer statutes with high levels of protection and indemnification for officers and directors, even more than those provided in Delaware and many other states. In addition, neither state has corporate income taxes. Similar to Delaware, Nevada has a business court that is designed to minimize the time and costs associated with commercial litigation. Nevada’s body of case law, while not as extensive as Delaware, is growing. Wyoming, as the most recent to the business-favoring table, lacks the bodies of case law that makes Delaware and Nevada so attractive.  Wyoming’s greatest advantage, and what really sets it apparent from Delaware and Nevada, is its low annual filing and maintenance fees, a topic detailed below. Like Delaware, Wyoming also provides some privacy to companies by not providing a public database with officer and director information. Nevada, on the other hand, does include a current list of officers and directors on its public database. Of course, both Nevada and Wyoming also lack the public company cachet provided by Delaware.

With all of these advantages, many new entities are anxious to file in one of these states instead of their home state.

 

But wait! What’s the catch?

While all three states offer business-friendly advantages in their statutes, there are also important drawbacks to consider with incorporating out-of-state. Namely, increased costs and administrative procedures.

An entity is initially responsible for formation costs. In Delaware, corporate formation costs are based on the corporation’s capitalization (the number of shares the corporation authorizes for issuance and the par value of those shares). Depending on capitalization, filing fees start at $89 and can go upwards of $9,000 (not to mention additional fees for extra document pages or certified copies!).  A corporation that authorized 1,000,000 shares at a par value of $0.001 would pay only $89 in formation fees, whereas one who authorized 1,000,000,000 at a par value of $0.001 would pay $274.

Delaware also charges annual franchise tax fees, which is where corporations face the highest potential costs. These taxes are calculated via two methods. The first, like the formation documents, is based on the corporation’s authorized capitalization. The corporation will need to pay $75 for the first 5,000 shares, $150 for 5,001 to 10,000 shares, and $75 for each 10,000 shares thereafter. For a company with 1,000,000 shares authorized, this puts the fee at a steep $7,650! Alternately, franchise tax can be calculated based on the “Assumed Par Value Capital Method.” This divides the total assets of the company by the total shares issued (as opposed to authorized) to determine the assumed par value. The assumed par value is then multiplied by the total authorized shares to determine the assumed par value capital. The franchise tax is calculated at $350 per every $1,000,000 of assumed par value capital. So for a company with gross assets at $100,000, issued shares at 500,000, and authorized shares at 1,000,000, the annual franchise tax would be the minimum due of $350. While certainly more palatable than $7,650, this expense will only grow as the company increases in value.

Nevada fees are similarly based on the capitalization of the company. Depending on capitalization, formation filing fees start at $75 and top out at a maximum fee of $35,000. Following the capitalization of our hypothetical Delaware entities, a corporation who has authorized 1,000,000 shares at a par value of $0.001 will pay $75 to incorporate, where has one who authorized 1,000,000,000 at a par value of $0.001 would pay $375 to incorporate.

As with Delaware, Nevada’s annual fees are where expenses can really mount. Annual fees in Nevada include an annual list filing and a $200 business license fee. The annual list filing fee is also based on the capitalization of the company.  Fees range from $125 to a maximum annual fee of $11,100. A corporation who has authorized 1,000,000 shares at a par value of $0.001 will pay $125, whereas one who authorized 1,000,000,000 at a par value of $0.001 would pay $375. Further, additional filings in Nevada, such as amending the articles of incorporation or merging entities also tend to be more expensive than other jurisdictions. A merger filing in Nevada is $350 compared to $239 in Delaware, or only $20 per merging entity in Washington State.

Wyoming, in comparison, is substantially less expensive. The formation filing is a flat $100. The annual report licensing is the greater of $50 or a calculation based on $0.0002 for every dollar of the entity’s assets located and employed in Wyoming. So for an entity that has no activity in Wyoming, annual fees would be only $50.  However, Wyoming’s financial advantages are counterbalanced by the lack of existing case law we previously noted. So while substantially less expensive, an entity still has a value decision to consider based on the increased expenses in Delaware and Nevada. Further, depending on the home state of the corporation, filing fees may be comparably inexpensive. In Washington State for example, incorporation is $180 and requires an annual renewal fee of $71.

Another disadvantage in incorporating out of the home state is the potential lack of a physical presence. This presents two issues. Firstly, all states require that entities maintain a registered agent. This is a physical address where service of process may be served in the state. When incorporating in a home state, this can be the business address, or the address of an officer or director. For entities not doing business in the state of incorporation, services can be hired to act as registered agent. This is an additional expense of  $100-$200 per year.  Secondly, it is important to remember that while you may incorporate in the state of your choosing, the business is still responsible for registering as a foreign entity in every state where it conducts business. This means that if you are a Delaware corporation with offices in Seattle and Portland, you will need to not only register in Delaware, but also Washington and Oregon. The procedure to register as a foreign corporation doing business in another state is simple, but it is yet another administrative procedure and cost for the entity to consider on an annual basis.

All of these expenses and filings can add up quickly for a new business running on a limited budget. So while Delaware, Nevada, and Wyoming all offer advantages, they are not the right choice for every prospective business. Many new businesses are simply better served by incorporating in their home states.

The article provided above is for general information purposes only and should not be relied on as specific legal advice. This article does not form an attorney-client relationship. If you have any questions about this article, please feel free to contact Amy Riedel at amy@apexlg.com



[1] Delaware Division of Corporations, “About Agency,” available at http://corp.delaware.gov/aboutagency.shtml.

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