One of the first questions I get from startups looking to incorporate is should we incorporate in Washington or Delaware? The answer to this question is a subject of ongoing debate among lawyers, and my aim here is not to try to resolve that debate. Instead, I want to share a few of the considerations I offer startups to help them make the right decision for their company.
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It’s always worth considering, as a startup, what your investors will want and/or expect to see when it comes to the way your entity is set up. It’s not always the end-all-be-all, but it is a relevant factor.
Delaware is widely acknowledged to be a business-friendly state with a well-developed and sophisticated body of corporate law. Venture capital firms are well-versed in and therefore comfortable with Delaware’s corporate law. Additionally, many of the startups these VC firms fund are Delaware corporations, meaning that VC firms can come to expect that startups seeking their money will be incorporated in Delaware. Most people have at least one story of a VC firm insisting that a startup be incorporated in Delaware as a condition of investing in the startup.
The reality, though, is that plenty of Washington startups incorporate in Washington and succeed in raising money from VC firms. My view is that, for many investors, the state of incorporation factors much, much less in their decision to invest than do things like the problem the startup has identified in the market, the solution to the problem, the underlying technology driving the solution, competition, and so on. If a VC firm is excited about investing in your startup, it’s unlikely that it will walk away simply because you’re incorporated in Washington.
Taxes and Expenses
Startups are typically cash-starved at the start and are looking to save wherever they can. Incorporating in Washington is a good way to preserve funds at the start, as the startup will only be paying filing fees in Washington and can have one of its founders serve as the registered agent.
If, on the other hand, the startup incorporates in Delaware, then it will have to pay filing fees in Delaware to form the corporation, it will have to pay for a registered agent service in Delaware, and it will have to pay Delaware taxes. But since it’s operating in Washington, it will also have to pay to register to do business as a foreign entity in Washington and also pay Washington taxes.
As a result, startups that incorporate in Delaware rather than Washington should expect to at least double their tax and regulatory obligations and expenses. While these aren’t astronomical expenses, they add up, and when cash is precious, it can be difficult to justify spending it in this way.
Usually, the advice I offer is to incorporate in Washington and, if any investor later shows reluctance to invest because the company is not a Delaware corporation, then—provided that the startup wants that investor’s money—convert to a Delwaware corporation. Converting from a Washington corporation to a Delaware corporation is not overly complicated or time-consuming, making it a viable pivot position for most startups that incorporate in Washington.
Related: How To Form A Washington Corporation