May 6 2007

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.