What is the Best State of Incorporation?

Question: What preferences do venture capitalists have for different possible states of incorporation?

(Jason) Most venture capitalists have 3 preferred states: Delaware, whatever state the company is in and whatever state(s) the VCs are located in. I’ll spare you the longwinded legal answer (I actually had a class in law school that was all about different states of incorporation and I’m still scarred from it), but Delaware law is well-settled, generally business friendly and most lawyers in the U.S. are adapt at dealing with DE law. If you are planning to consummate an IPO, you’ll have to be a DE company, as no bankers will let you go public unless you are.

The disadvantage of being a DE company if you are not in DE, is that you’ll have to pay some extra taxes (not much) and potentially comply with two sets of corporate laws. For instance, if you are located in California and are a DE corporation, you’ll have to comply with DE law and some of CA law too, despite you being a DE corporation.

Perhaps the coolest thing about being a DE company, is that they accept faxed signature pages and can approve changes in corporate documentation faster than any state that I’ve worked with. This is particularly helpful when you are trying to close a financing or merger deal on a short leash. I tell people that it’s worth the extra few hundred bucks a year to be able to use your fax machine.

As for the other two choices: the physical state of location of the company and he state(s) where the VCs have offices, it’s pretty self explanatory. Assuming the company is not in a state where the VC has never invested (and is unfamiliar with how the laws work) then it’s perfectly fine to be incorporated in that state. Similarly, whatever states the VC has offices in, they are generally amenable to being subject to those laws as well, so incorporating in those states is fine too.

Remember, the issue here is that the VC will join your board and be personally liable under that state’s corporate laws. The laws vary much more by state than most people realize. I’d say 75% of our companies are DE corporations.

  • What if the founders are from a foreign country (e.g. Canada)? What would a VC prefer/recommend in this situation, because alongside additional taxes for a DE corp, there are other requirements in place.

  • Jason

    Assuming that they want to stay in Canada and work, many VCs would prefer that the headquarters still be located in the U.S. (probably DE) with a development office in Canada / foreign country. If the company really has no activity in the U.S., then clearly it’s location of domicile will be that country.

  • “Perhaps the coolest thing about being a DE company, is that they accept faxed signature pages and can approve changes in corporate documentation faster than any state that I’ve worked with.”
    I’m being a bit of a troll here, but is it possible that they approve these changes faster because they’re paying less attention to what’s going on, being that they deal with so many corporations all the time?

  • Jason

    Good comment and I’m not sure, but my guess is that they are paying just as much of attention as any other state. Now whether ANY state is providing enough oversight, that is a debate.
    I’ve had as many pieces of paper “bounced” from DE as any other state, meaning somebody is looking at stuff over there.

  • Jason

    This from reader Logan M. Cheek:
    Here’s another state posing a challenge from a shareholders’ (possibly VC) standpoint. I was recently invited to invest my partnership into a NY based med tech venture. A significant existing investor who controls the board but not (yet) the majority of shares is a NY based public company. In checking out the potential public partner, we discovered they were (a) in financial trouble and (b) had recently reincorporated in Nevada. On further checking, one of their (irate) shareholders shared the following gem:
    The company recently changed its incorporation from Idaho to Nevada, even though … (it) … has never been located in Nevada or has ever done any business in Nevada. Why Nevada and not New York, where its operations are located?
    Almost every state has adopted corporate statutes that limit the liability of any of its representatives which includes Officers, Directors and Stockholders.
    Yet Nevada has gone one step further, very specifically spelling out in its statutes that all corporate representatives are free from personal liability from corporate activities except in cases where fraud can be proven.
    So let’s just say for now that, absent being located in Nevada, a corporation incorporating there, or transferring its corporate charter there should be a VC’s due dilly red flag.

  • I see also that North Dakota is starting 2 also want your ‘incorpoation’ business

  • I think that the Cayman Islands needs to be considered as a jurisdiction of incorporation for companies with operations/revenues outside the U.S. I think the Cayman Islands started to become a popular jurisdiction for incorporating China-based venture-backed companies around 2002/2003. Many venture funds seem to be getting comfortable with the Cayman Islands as they start to do more Asia deals.