One of the first decisions made when forming a new corporation is the choice of the state in which to incorporate. In theory, a new business can be incorporated in any one of the fifty states. In practice, however, only a few states are commonly considered. For California-based businesses, these states are typically California, Delaware and Nevada. The selection of any state can have far reaching consequences. Therefore, it is important to understand the pros and cons of each state's corporation law.
Each year, tens of thousands of businesses incorporate in California. Indeed, for many businesses located in California, choosing to incorporate in this state may seem to be both logical and appropriate. California does have a relatively modern and well-organized corporate law with which most California lawyers are familiar and comfortable. Surprisingly, California's fees for incorporation are relatively modest. The California Secretary of State's filing fee is $100 regardless of the assets or number of authorized shares.
Many lawyers, however, find California's corporate law overly rigid and constraining. For example, California is among a minority of states that require that stockholders be given the opportunity to vote cumulatively in the election of directors. Cumulative voting is a method of voting that is intended to allow minority shareholders to elect one or more directors. California also doesn't have a specialized business court and judges hearing a corporate law case may have little or no background or experience in corporate law.
For publicly traded companies, Delaware has long been the jurisdiction of choice. Delaware's corporation law is regarded as more flexible than the laws of many other states. For example, Delaware doesn't mandate cumulative voting as does California. However, the biggest attraction for many lawyers is Delaware's specialized business court, known as the Court of Chancery. This is a centuries old court that specializes in deciding corporate and business law disputes. The judges, known as chancellors, of these courts are extremely well regarded and highly influential. Courts throughout the country frequently refer to Delaware court decisions. Thus, many lawyers and their clients feel comfortable having their disputes settled by a highly experienced and specialized court.
Choosing Delaware, however, is a more expensive option for a California-based business. Delaware imposes an annual franchise tax. The franchise tax in Delaware is not an income tax, but a tax for the privilege of being a Delaware corporation. For some corporations, the franchise tax can run as high as $165,000 per year. That means that in the course of 10 years, some corporations will pay the State of Delaware more than $1 million just to have a Delaware charter and access to the Delaware court system!
Moreover, complicated corporate law issues may require businesses to retain Delaware counsel in addition to California-based counsel. Finally, businesses should recognize that litigation in Delaware can result in significantly higher litigation, travel and other costs for a business that has no physical presence there.
In the last few years, the State of Nevada has tried to compete with Delaware as the state in which to incorporate. In many instances, Nevada has tried to adopt Delaware's positive corporate laws and take them one step further. Thus, in many ways, Nevada can be viewed as Delaware "on steroids." For example, Nevada significantly limits the potential liability of both directors and officers while Delaware allows for limitations on the liability of directors only.
Nevada, however, should not be regarded as being clearly better than either California or Nevada as a corporate domicile. Nevada does not have a counterpart to Delaware's Court of Chancery. It remains to be seen whether the Nevada courts will garner the same degree of respect as Delaware's. Also, some people are attracted to Nevada for the wrong reasons. One reason often given for incorporating in Nevada is the fact that Nevada does not have a corporate income tax. While this is true, a business in California cannot evade California taxes simply by incorporating in Nevada. California businesses with income from a California source will be subject to California tax.
If a California-based business is considering incorporating in another state, it may find that it is not getting everything that it expects. One reason is that California has adopted several statutes that impose California's requirements on corporations incorporated elsewhere. These "clawback" statutes are controversial and being tested in the courts. In the meantime, they remain on the books and must be considered by expatriate corporations.
The decision of where to incorporate is an important one with far reaching consequences. It may mean the difference between being in court a few miles away in Santa Ana or thousands of miles away in Dover, Delaware. It may mean the difference between personal liability and immunity. Thus, it is a decision that should be made on a careful and informed basis.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
