This Is Why I Did Not Incorporate My Startup in Delaware.
Much of what I read during my nascent entrepreneurial journey, said that incorporation was often a late step to succeed a working prototype. However, while I have worked through a number of early prototypes so far (some quite widely variant from prior ones), I haven’t been able to convince myself yet that any one of them was the golden goose that I could go all-in on.
I thus decided to bite the bullet and form a corporation anyway. Why?
on a personal note, I finally get to go “all-in” with my current idea (though to be fair, I quite like its prospects);
on a financial note, I get clear tax benefits and liability protection;
on an experiential note, I get the education that comes from going through be the process of incorporation.
Tax Implications
It turns out that a “single-member limited liability corporation” (SMLLC) is actually not that much of a tax-related burden at all. At a pinch, I just have to file an extra form each to the state and the federal government every year, along with my regular income tax filing. I haven’t read the new tax law too deeply, but I also may now be able to get access to the gaping loophole it created.
I can even hire employees fairly seamlessly. I only need an Employee Identification Number (EIN), which is quite easy to get (and doesn’t have any extra tax filing burden unless revenues increase manifold). I also need to file and pay employer payroll taxes, which isn’t that complicated, and is no surprise anyway.
But why does the Internet suggest Delaware?
These are the three reasons it boils down to:
It’s cheaper. More about that later.
An oft-repeated phrase: “the business friendly nature of Delaware’s corporation laws”. I saw this on a number of blogs and websites. While I understand its relevance to a large or rapidly growing corporation, I’m not sure why this even matters to a tiny organization that has limited resources and is just trying to get things done quickly. And New York State’s body of law is no joke: just ask Argentina.
“All tech startups do it.” This makes me most suspicious.
“In fact, they don’t just do it, they use Clerky to do it.” VCs like YCombinator make it kind of mandatory to have a Delaware C-Corp in order to be funded by them. Y-Combinator literally owns a part of Clerky, which is a clear case of an ulterior motive, deliberate or otherwise.
It can be argued that other VCs that also mandate it, are just being lazy. (It’s similar to the “we won’t sign an NDA because ideas are cheap” argument. The fact is that the power dynamic almost always lies squarely on the side of the VC. Ergo, Occam’s Razor leads me to believe that a better explanation is laziness, like I said earlier.)
A startup should really be tackling a problem only when it IS a problem. There are a number of Quora posts that bemoan the complexity of having to convert a complex legal entity to a different complex entity. But if a firm is at the point that it needs to do appropriate tax and domicile readjustments, then it doesn’t really matter that the firm is saving $10,000 in year five by having invested $1,000 in day zero to create a Delaware LLC. On day zero, you have better things to do with your time.
“It’s Cheaper”: A Quick Cost-Benefit Analysis
Here’s what it costs me to incorporate and do business in New York State vs. in Delaware:
Recurring Fees
$25 a year by 15th March in Annual Filing Fees for New York State (it’s an escalating scale, but it will be awhile before a typical LLC’s revenues catch up to Delaware’s fixed fee), vs. a fixed $300 by 1st June in Delaware.
$0/year since I am my own agent in New York State, vs. say $100/year if I maintain a mandatory Registered Agent in Delaware.
$x in taxes paid to New York State for a New York State LLC, vs. $x in taxes paid to New York State for a Delaware LLC. The LLC doesn’t file or pay taxes in Delaware if it isn’t doing business there.
$0 in franchise taxes paid to New York State since my LLC is neither an S-Corp nor a C-Corp for tax purposes, vs. either $0/year or $300/year paid to Delaware (Googling did not clarify for me whether Delaware considers SMLLCs exempt from franchise tax).
(I’m sure I missed something.)
One-Time Fees
$200 to file the Articles of Organization in New York State, vs. $90 in Delaware.
$0 to do the incorporation process online myself in New York State, vs. say $125 to do it in Delaware on one of the popular service websites.
$0 to not be a foreign LLC in New York State, vs. $324 in Delaware($225 to file an Application for Authority to do business on behalf of the foreign Delaware LLC within New York State, plus $99 to get a Certificate of Good Standing from Delaware).
$0 to not publish two notices of incorporation in public newspapers in New York State, vs. $0 to not publish in Delaware since its laws don’t require it. This needs an explanation:
New York mandates that it be done within 90 days of incorporation, even for an SMLLC. It also costs a ton of money to publish it in the five counties of New York City: something in the region of $1,500. (New York Law Journal even has a convenient monopoly going for it.)
It can be gotten around by instead incorporating in a much cheaper part of New York State, finding a registered agent there for say $50, publishing the notices for say $300, and then moving the firm back to New York City… but that’s a lot of work, and makes it indistinguishable from the hassle of incorporating in Delaware in the first place.
But there’s a nice third alternative, which is to delay doing it altogether until a situation arises where New York State needs to produce a Certificate of Good Standing for your LLC. (A typical situation would be a rare one, like if your LLC wants to sue someone.) In such a scenario, the publication of the notices can actually be made at that time, and then become retroactively valid as of the date of original incorporation! A caveat here is that it will take three months or so to complete the publications if the LLC ever finds it necessary to get back to good standing in New York State.
Technically, the business loses its ability to conduct business in New York after 90 days. However, it seems like there is nothing substantive in New York State laws, or in legal precedents, that actually penalizes a firm in any way for not publishing their notice of incorporation within that time.
To End Things…
I’m no lawyer. (I’ve never understood the point of this disclaimer, to be honest. I wrote it so that any lawyers reading might explain why this is so common.)
More importantly, please correct me wherever I was wrong, and I will happily update my post with credit.