Although Delaware is the second smallest state in the United States, it has attracted nearly 1.5 million U.S. and international business entities to make it their legal home, 67.8% of which being Fortune 500 companies (according to a 2019 Delaware Division of Corporations Report). Since the early 1990s, the flexibility offered by the Delaware law has enabled Delaware to become the recognized center for business formation and nearly 50% of all Wall Street-listed companies are incorporated under the Delaware law.
Hence, the question arises as to why so many companies decide to choose this particular US state to incorporate their business entities in.
Prior to discussing the benefits of incorporating in Delaware, let’s discuss the reasons why a European entrepreneur planning on incorporating in the US should choose a C-Corporation (“C-Corp”).
Why a C-Corp?
When forming a business, the first question one should think about is the type of entity that best suits their needs. A few things to consider would be: entity structure, liability, tax implications and corporate management.
A C-Corporation has the following characteristics:
– It has a formal management structure;
– It has owners (shareholders) and a management team (directors and officers);
– The shareholders have limited liability and, generally speaking, are not personally liable for corporate debts; and
– It is a distinct legal entity apart from the shareholders with its own set of rights and obligations.
The most common form of company is the C-Corporation, which is subject to two levels of US federal income tax:
– at the corporate level when profits are earned
– at the shareholder level when profits are distributed as dividends or otherwise to the shareholders.
In fact, all corporations are C-Corporations by default, unless they take one of the following two steps:
– file Form 2553 with the Internal Revenue Service (IRS) to be classified as an S-Corporation or
– file a 501(c) application form with the IRS for a non-taxable status (a non-for profit company/charity).
Since the C-Corporation is a separate entity from its shareholders, one of its benefits lies in the limited liability it offers to its shareholders. Thus, shareholders are protected by the corporate shield, which is the concept where – subject to the corporation following certain requirements (e.g., keeping accurate books and records, not commingling corporate assets with those of the shareholders, or whether the corporation is merely a façade for the operation of the dominant shareholders) – generally speaking, the shareholders, officers and directors of a corporation will not be held personally liable for the actions of the corporation.
In addition, C-Corporations are often favored by venture capital and investors. As a matter of fact, more than 89% of new IPOs were undertaken by Delaware C-Corps in 2019 (Delaware Secretary of State Corporate Annual report for 2019). For that reason a venture capital firm that is willing to invest in a company that is not a C-Corp or which is not incorporated in Delaware may require that the target company re-incorporate in Delaware as a C-Corp before the venture capital firm is willing to make the investment.
Why Delaware?
With about 50% of Wall Street-listed companies registered in Delaware, why is this US state preferred by foreign companies that want to establish themselves in the US?
The flexibility and ease of forming a company in Delaware are universally known , hence it is the preference of many corporate directors to register their company in Delaware, even though they conduct activities in other states.
In order to incorporate, companies usually turn to Delaware for a number of reasons such as:
(i) low franchise taxes:
(ii) the ease of the incorporation procedure (which includes the ability to file online):
(iii) a well-developed body of corporate law and well respected, knowledgeable judges;
(iv) superior jurisprudence and precedent setting court decisions; and
(v) statutes and legislation that are meant to favor business owners
Additionally, as the disclosure of company shareholders, directors and officers is not compulsory in Delaware, the state provides a guarantee of anonymity and allows the preservation of confidentiality of the shareholders’, directors’ and officers’ information (such as their names and addresses).
However, a company will still need to appoint a Registered Agent on its Certificate of Incorporation in order to receive service of process, legal correspondence from the State of Delaware and other legal notification on behalf of the entity.
Nonetheless, it is important to keep in mind that other states may sometimes be better suited. For instance, where a company’s business activities are mainly concentrated in one particular state, it may be smarter to incorporate it in the said state as it will notably be easier to obtain state licenses.
How to form a Delaware C-Corp : Procedural Steps for Incorporating in Delaware
How to form a Delaware C-Corp ? Before deciding to incorporate in Delaware, there are several issues to consider, including:
(i) The preferred state of incorporation.
Corporations are governed by and subject to the laws of the state in which they are incorporated. In Delaware, the statutory authority governing corporate law is the Delaware General Corporation Law (DGCL).
(ii) The name of the corporation.
The DGCL §102(a) requires that the corporate name contains the abbreviation of, or one of, the following words: “association,” “company,” “corporation,” “club,” “foundation,” “fund,” “incorporated,” “institute,” “society,” “union,” “syndicate,” “limited,” or similar words from foreign jurisdictions.
Moreover, before filing incorporation documents, one must approach the applicable state office to check whether the desired corporate name is available. Upon name designation, incorporators can reserve it for a certain fee and period of time to make sure the preferred name is available when the entity is ready to incorporate.
Before incorporating:
Once the previous steps are fulfilled one still has to take logistical measures, namely: (i) ordering a minute book, (ii) determining whether to use a service company, (iii) whether the filing must be expedited and (iv) who the incorporator, the initial director(s) and officer(s) should be.
The Delaware General Corporation Law (I Del. C. §131 and §132) requires companies to appoint a registered agent that must fulfill the following conditions:
o Be a legal resident of Delaware (either an individual or a company)
o Have a physical location in Delaware where it can, during usual business hours, accept service of process, legal notifications and annual report notifications
o Provide reliable means to forward all documents received to the parties in charge
o Keep on file the name, business address and business phone number of a natural person serving as the communications contact on behalf of the corporation.
Then, there are a few procedural steps to follow in order to organize the corporation.
First, the incorporator (usually the lawyer representing the future directors of the corporation) files the certificate of incorporation with the Delaware Secretary of State. Then, by means of an “action by incorporator”, the incorporator acknowledges receipt of the registration, appoints directors and drafts the post-registration resolutions for signature by the directors. The directors subsequently approve both the by-laws and the company registration via the certificate of incorporation, appoint officers, approve the dates of the tax year, authorize the opening of a bank account, issue a number of shares of stock for the company, determine their nominal value and to which shareholder the shares of stock are granted, and issue stock certificates representing those shares.
After incorporating:
After forming the corporation and appointing the directors and officers, but prior to starting to conduct business, a corporation must:
(i) Check the specific requirements of each state (other than the one of incorporation) in which the corporation intends to do business, including checking the name availability, preparing and filing the necessary state-specific documents (such as a Statement of Designation in California or an Application for Authority in New York) and paying filing fees with the state authorities;
(ii) Apply for an Employer Identification Number (EIN) with the Internal Revenue Service. This EIN number is needed for tax and reporting purposes, and to identify the said corporation. This step can be fulfilled online;
(iii) Apply for any licenses or permits needed to conduct business. Specifically, if the company wishes to conduct business outside of Delaware (for instance accepting customer orders, paying employees or holding company assets in other states), it must apply for a “foreign qualification”. The requirements to obtain a “certificate of authority” differ from state to state, but they usually include providing a certificate of good standing from the State of Delaware in support of the application, in addition to retaining a registered agent in every state in which the foreign company is looking to qualify to do business;
(iv) From the year of incorporation onwards, a corporation must file online a Domestic Corporation Annual Report and pay franchise taxes in Delaware for the prior year.
If you still have questions as to whether or not your foreign company should incorporate in Delaware, please contact the author of this article and business attorney Stephan Grynwajc who is licensed in the U.S., France, UK and Canada and who has been assisting foreign companies to navigate the U.S. corporate landscape. Stephan can be contacted at: stephan@transatlantic-lawyer.com
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