I get asked this question at least 5 times a week. When I ask, “Why? What would be the benefit?”– not many, if any, can answer my question. They just know they’ve “heard” it was better for one reason or another, or they seem to think it would be cheaper.
Although, given individual circumstances, this may be true, it could be a very bad decision for a small business owner to make, and more often than you think.
There are several, very persuasive reasons why a business owner might consider incorporating in Delaware. For a business owner with a global idea of ‘going public’ in the future, Delaware might be an option. Going Public is when a company becomes a publically traded and owned entity. Businesses usually do this to raise capital for the business, to expand in size or production. Delaware is also a great place for a business looking to obtain Venture Capital Funding. Venture Capital Funding is usually an investment operation that manages the money of multiple investors seeking private equity stakes in startup and small- to medium-sized enterprises with strong growth potential. These investments are generally characterized as high-risk/high-return opportunities. These are concrete reasons for considering Delaware as your incorporating State.
For many small business owners (which make up most of my clients), Delaware is not the answer, and may not be for you either. Most of the small business owners I work with are unlikely to opt for either option mentioned above, at least in the beginning. Nevertheless, if your company grows, going public or seeking Venture Capital funding are available options down the road.
So, what are some of the mythological benefits of incorporating in Delaware?
• No Income tax
Well, kinda. Delaware’s corporation income tax is assessed at a flat 8.7% of taxable income derived from Delaware, meaning income actually made in the State of Delaware.
So, if your business is not physically located in the State, there would be no Corporation Income Tax. Great news, right? However, what many fail to recognize is that there is actually a Franchise Tax that still has to be paid.
Delaware LLCs, limited partnerships, and general partnerships are required to pay an annual tax amount based on what’s called the authorized shares method or the assumed par value capital (whichever is lower).
o Now, if that hasn’t confused you, then this will just annoy you. In the end, chances are you won’t save any money, because in addition to the Franchise Tax in Delaware, you would be required to pay New York State taxes on the income you make. This brings me to my next point.
o Even if you and your attorney do see a benefit in forming your business in Delaware, you have to be careful to be in compliance with New York State business law, because your business would be what is known as a “Foreign Entity,” requiring you to register and pay a fee in New York State. The NYS Business Corporation Law provides that a foreign corporation may not do business in New York, until it is authorized to do so by the New York State Department of State (DOS). You could be looking at some hefty fines (and attorney’s fees), if you get caught violating this provision.
• Delaware allows for quicker formation because it offers online filing.
Well, that statement is actually true. What makes it a non-factor for small businesses here in NYS is, that NYS offers expedited processing too.
• Delaware Courts are easy on corporations
Out of all the mythological benefits, I personally think this one is the most ridiculous. Registering your business in Delaware does mean that any dispute could be handled in the Delaware Courts which will no doubt lead to frustrating jurisdictional issues and of course, cost you more money. Wasn’t the initial purpose of incorporating in Delaware to save money?
Some of the other benefits I’ve heard regarding Delaware are protections against hostile takeovers, shareholder’s redemption rights and cumulative voting. Not only would I bore you to death defining and discussing these things, they wouldn’t be a benefit to a smaller business, because they are not applicable. So, thank me later for saving you the time and aggravation of an explanation.
What’s the point? When starting a business and considering the benefits of incorporation, talk to an Attorney who will explain what’s best for you and your legal needs. Sure, there are a lot of options to do-it-yourself, but don’t get trapped in the maze of mythological benefits of incorporating in another state.
N.Y.S. is just as fine a State in which to incorporate, and the benefits of another state do not always outweigh the costs and the headaches that come with it.
If you’re ready to get going here in New York, I’ve got everything you need to do just that. And for less than it would cost to retain an attorney! CLICK HERE to get started now.
Crystal J. Rodriguez is an Attorney in Buffalo, New York specializing in areas such as business and non-profit formation and wills & estates.