What State should you choose for your Entity Formation?

When forming your entity, it is important to carefully choose your state of incorporation or formation, because your entity's "internal affairs" will be governed by the laws of that state. Here are some important factors to consider when choosing your company's state of incorporation or formation.

Cost Considerations

In whatever state you file, there will typically be recurring fees that you will need to pay, and these fees vary significantly state to state. If the state where your business is incorporated or formed is different from where you business is located, you will need to pay additional fees for a registered agent (a designated recipient for state mail addressed to your business) in the state of incorporation or formation. In addition, if your business is formed in a state other than where it is located, you may need to register your business as a "foreign entity" in the state where the business operates. This would lead to having to pay state fees in more than one state.

Because of these cost factors, many businesses are formed in the state where their headquarters or primary operations are, or where the founders live. That is often going to be the cheapest option available. 

State Law Considerations

However, there are certain factors which would typically push you to form in a different state than where you are located regardless of the cost. The most common scenario for this is where institutional investors require that you be incorporated in Delaware before they are willing to invest, or if you are planning an IPO and your IPO underwriters feel like you should be a Delaware entity before your IPO. 

There are a several reasons why Delaware is a popular state to incorporate/form your business, and here are a few of the most common reasons:

1. Delaware laws are generally structured to be business and investor-friendly. For example, some investors are granted the right to appoint an individual to sit on the board of directors. It is important for that individual to know that directors will not be held personally liable to company stockholders if the director acts in good faith when they make a decision on the board of directors. In Delaware, the laws are very clear that this is the case. 
2. Because so many companies are formed in Delaware every year, the Delaware laws governing entity formation and governance have been very well fleshed out. There is a larger body of case law interpreting the application of Delaware business laws than any other state, so it means there is less risk that a law may be applied in an unexpected way.   
3. Delaware is one of only a few states that has a judicial court system dedicated entirely to business law disputes. This means that there is less risk that the application of Delaware's business laws is going to be anything other than predictable and consistent. 

Other states may have laws just as good as Delaware does when it comes to being business-friendly and investor-friendly, but there is risk in how the judicial system will apply that law. It is the combination of "business-friendly" along with "predictable application of the law" that makes Delaware the state of choice for companies that plan to raise money from investors. Investors are risk-averse, and Delaware is typically seen as the state that carries the least amount of "legal risk" as a state of incorporation or formation. 

Making Your Decision

All things considered, choosing a state in which to form or incorporate your entity will depend on your specific circumstances and many factors, and we recommend you discuss your situation with an attorney as well as with tax advisors. Incorporating in Delaware might be unnecessary for your company goals, or it may be a requirement of current or future investors. If you don't anticipate the need to raise capital from investors or an IPO,  it might make more financial sense for your company to incorporate in your home state (depending on your state laws, of course).

In some cases, some founders are trying to save as much money and cost as possible up front, but are planning on raising money down the road. In that case, you can sometimes choose to file initially in your local state and then convert into a Delaware company later. This sometimes works fine, though you should keep in mind that, while some states allow you to change your filing state (often called "domesticating" or "converting" your domestic filing state), some states do NOT allow this, and even then it will cost additional money to go through this transaction and it often is cheaper (and more beneficial) to simply incorporate in the right state during the initial entity formation process. 

Regardless of what state you decide to form your entity, PaperOS can help you get started, in part because we have filing agents and registered agents in all 50 states! We will also be a tool you can continue to use as your business continues to grow after formation. 

PaperOS is not an attorney or a law firm, and can only provide self-help services at your specific direction. Do not rely on any documents or information from PaperOS without consulting an attorney. PaperOS may partner with or refer clients to licensed attorneys, but such referral does not constitute an attorney-client relationship until the attorney is officially engaged by the client.