With regard to the question of where to domicile the business, there are basically three (3) choices: (i) Offshore, (ii) Delaware, or (iii) the state where they will physically be conducting business.
Going “offshore” is always an option, motivated by saving on taxes and asset protection (primarily from lawsuits). This inquiry is an exotic area populated by (very) high-priced lawyers, accountants and trust representatives. It is an easy opportunity to spend (and waste) a great deal of money. The issue is one of timing in working on an endeavor that will not favorably impact the company’s success in starting up its business and has the likelihood of wasting a great deal of money and valuable management time. An analysis of offshore opportunities is a worthy endeavor once the company has validated its business vision and commenced operations and met certain agreed milestones.
Delaware is the domicile of choice for most US public companies and for late-stage startup companies that are about to go public. Delaware has a well-developed body of corporate law that most business lawyers are familiar with and that offers a number of advantages that help to shield existing management from unwelcome change (e.g., ability to eliminate cumulative voting and to stagger the election of directors).
Even though those rights are not as significant for management of non-public companies, there is a common practice to organize in Delaware on the theory that venture capital investors will be more likely to invest in a Delaware entity. Also, many entrepreneurs (and some of their lawyers) are not aware of any substantive significance of a Delaware organization. One key such unique provision under Delaware law is the ability of the preferred shareholders, acting alone without the approval of common shareholders, to approve a merger of the company. A typical set of preferences for all venture capital investors include a liquidation preference (i.e., the right to recoup their investment with or without some minimal threshold rate of return before common shareholders are entitled to any dividends or other distributions. The unilateral ability to approve a merger coupled with a liquidation preference gives preferred shareholders a “loaded gun” option to sell the company for a sum of consideration that would recoup all or part of the preferred investment and leave nothing for the common shareholders.
Home State Domicile
Assuming that your company does its business and has its executive offices, not in Delaware, but in another state (its “Home State”), founders should consider the advantages to the founders of organizing their currently (and for the foreseeable future) private (non-public) company under the laws of its Home State, rather than Delaware. If, for example, the Home State were California, the only two advantages of note of Delaware relative to California would be (i) Delaware’s requirement of only one director, whereas California requires at least three directors (except, however, if only one shareholder, then only one director is required in California, and if only two shareholders, then only two directors required in California) and (ii) faster filing and providing copies of documents in connection with a funding. While same-day filings and confirmations are standard in Delaware, California 24 hour turnaround filings are an additional $350 in California and “same-day” turnaround filings are an additional $750. A California Certificate of Good Standing takes 24-48 hours and cannot be expedited. Copies of Articles, Amendments and annual filings take 4-6 business days and cannot be expedited. Advantage (i) might be helpful in facilitating corporate governance in an early-stage startup, and (ii) item two might be helpful in closing a funding event.
Apart from the foregoing, organizing in Delaware will merely add an administrative burden to a startup with a Home State like California, including the difference in the way franchise taxes are calculated and paid and the need to qualify and pay franchise taxes in Home State (in addition to payment in Delaware). In addition, there are risks, referenced above, to founders of losing value in a future merger in a transaction in which they have no right to approve or disapprove.
Given the disadvantages and the very limited advantages of a domicile in Delaware rather than a Home State like California, my usual recommendation is to domicile in the Home State. Later, when and if you interview prospective venture capitalists, you can discuss their level of commitment to a Delaware domicile. If they are excited about the company and its technology/products, they may put less emphasis on the nuances of state corporate law differences and agree to defer the Delaware reorganization until a public offering becomes a reality. Second, if immediate organization or reorganization in Delaware is mandated, then perhaps a frank discussion of merger approval rights by common shareholders would be effective. In any event, there is little to be gained by anticipating an unfavorable resolution of the issue and organizing as a Delaware corporation at inception.