For any US business, deciding where to incorporate is an important decision that can have far-reaching effects on the business's operations and future growth. For many US-based businesses, the choice is between two states: Delaware and California.

As of 2022, more than 1.9 million businesses has made Delaware their legal home. This includes many Fortune 500 giants, who often favour Delaware's business-friendly laws and judiciary. Conversely, California – despite its more stringent regulations and higher taxes – is home to a vibrant entrepreneurial environment that includes more than half of the world's "unicorn" startups (privately held startups valued at over US$1 billion).

When choosing between Delaware and California, US businesses must look at the differences between the states' legal frameworks, tax implications and privacy protections, while measuring the impact of these features on business growth and investor appeal. Below, we help guide US businesses through this process by covering the distinct advantages and disadvantages of incorporating in each of these states.

What's in this article?

• Benefits of incorporating in Delaware
  
• Benefits of incorporating in California
  
• Potential downsides of incorporating in Delaware
  
• Potential downsides of incorporating in California
  
• Incorporating in Delaware vs California: Key differences
  
• How to decide which state to incorporate in
  

Benefits of incorporating in Delaware

Delaware is a popular choice for incorporation due to its business-friendly laws, legal system and services. Nearly 80% of all US initial public offerings in 2022 were registered in Delaware and 68% of Fortune 500 companies are incorporated in Delaware. Here are some of the benefits that have contributed to these high figures:

• Flexible corporate laws
  Delaware's General Corporation Law is one of the most advanced and flexible corporate statutes in the United States. The state's laws are generally favourable to businesses and offer flexibility in terms of a corporation's structure, the rights of shareholders and company management. Delaware's corporate laws allow businesses to engage in mergers and acquisitions more easily, provide advantageous conditions for venture capital and private equity investments, and offer mechanisms for asset protection and estate planning.

• The Court of Chancery
  The Delaware Court of Chancery specialises in corporate matters and uses judges – not juries – to make decisions. This court is highly respected and boasts a rich case law specialising in business matters. This means that the court has already addressed many legal issues over the years, providing greater predictability and legal stability for businesses incorporated there. The judges in the Court of Chancery are appointed based on merit, which contributes to the court's high level of expertise in corporate law.

• Privacy protections
  In Delaware, corporations are not required to disclose the names of their officers or directors in the formation documents. This provides corporations with a level of privacy that is not available in all US states.

• Tax advantages
  Delaware does not impose income taxes on corporations based in other US states or other countries. If a business incorporates in Delaware but doesn't do business there, it is not subject to state corporate income tax (although there is a mandatory franchise tax). Furthermore, a business's shareholders do not need to pay Delaware taxes on their shares if they don't live in Delaware.

• Investor attraction
  Many investors prefer investing in Delaware-based corporations, due in part to Delaware's well-established body of law and Court of Chancery. Additionally, the state's laws tend to favour management, which can offer more predictability for investors.

• Ease of incorporation process
  Delaware has a streamlined and efficient incorporation process. The state's Division of Corporations offers expedited processing services, which can simplify the formation and management of a Delaware corporation.

• Shareholder-friendly laws
  Delaware's laws tend to be favourable to management, but they also hold unique advantages for shareholders. For example, it's possible in Delaware for one person to be the sole director of a corporation and hold all officer positions. In addition, shareholder meetings can take place anywhere, even online.

• Predictable and established precedents
  Over many years, Delaware courts have developed a vast body of case law that provides legal predictability for corporations. This substantial legal precedent can help to resolve complex legal issues in a faster and more predictable way than in US states with corporate case law that is not so developed.

Benefits of incorporating in California

Incorporating a business in California offers several advantages, particularly for companies that intend to do most or all of their business within the state. Here are some key benefits to consider:

• Local operations
  If a business is physically located in California and plans to operate primary within the state, incorporating in California could be advantageous. This can make compliance easier, and it can also cut down on fees and paperwork as the business won't need to qualify as a foreign entity to do business in California.

• Credibility and recognition
  As with incorporating in Delaware, incorporating in California can provide businesses with a sense of credibility and legitimacy – especially those that operate within this US state. Customers, suppliers and investors might see a California corporation as being more firmly established or more committed to building local relationships.

• Familiarity with local laws and regulations
  Incorporating in California can make it easier to navigate the legal environment, particularly if the business plans to conduct the majority of its activities within the state itself. The company will be subject to California law, making legal guidance more straightforward and localised.

• State-specific protections
  California law provides certain protections for shareholders of corporations that may not be available in other states. For example, California has strong laws in place to protect minority shareholders from unfair treatment.

• Access to capital and markets
  California is a well-known hub of venture capital, innovation and entrepreneurship – especially in Silicon Valley and the San Francisco Bay area. Businesses in tech or other high-growth industries may benefit from proximity to these resources and networks.

Potential downsides of incorporating in Delaware

While incorporating in Delaware offers many advantages, there are potential downsides. Here are some key points that businesses should bear in mind:

• Franchise taxes and fees
  Every business that incorporates in Delaware, whether they do business there or not, must pay an annual franchise tax. The minimum franchise tax is US$175 for most corporations, but it can go up to US$200,000 for larger entities. In addition, Delaware corporations must also pay an annual report fee of US$50.

• Costs of operating in another state
  Typically, if a Delaware corporation conducts business in another state, it is considered to be a foreign entity in that state. As a result, the corporation may have to qualify to do business in that state, which could involve additional fees, paperwork and potentially paying taxes in both Delaware and the other state.

• Legal complexity
  While Delaware's Court of Chancery – and the court's established body of corporate law – provides businesses with predictability and consistency, it can also create complexity. The depth and complexity of Delaware's legal code may require businesses to seek specialised legal counsel, which could increase costs.

• Less friendly to smaller businesses
  While Delaware's legal framework benefits large corporations, particularly those seeking venture capital or planning to go public, it may be less advantageous for small businesses. Small businesses, especially those that will not have significant out-of-state operations, may not benefit from Delaware's corporate laws to the same extent.

• Perception of "hiding"
  While the privacy protections that Delaware offers can be advantageous, they can also create a perception that a company is trying to hide something. Some stakeholders may view incorporation in Delaware as a way to hide the identity of owners or officers, or as a way to take advantage of laws that are less strict than those in other US states.

• Shareholder lawsuits
  While Delaware's laws are generally friendly towards management, the US state is also known for shareholder litigation. The state's developed body of law and specialised court system could make it easier for shareholders to bring lawsuits against a corporation.

Potential downsides of incorporating in California

While there are many benefits to incorporating in California – especially for businesses planning to operate primarily within the state – there are also several potential downsides, including:

• Higher minimum taxes
  All corporations in California, regardless of income or activity level, are subject to a minimum franchise tax of US$800 per year.

• Strict regulations
  California is known for having more strict and complex business regulations than many other states. There are more rules about how a corporation can be structured, as well as regulations covering certain areas, such as environmental standards, labour laws and privacy – all of which can impose additional compliance burdens on businesses.

• Cumbersome bureaucracy
  Some businesses find California's bureaucratic processes to be slow and cumbersome. The time and effort required to navigate these processes can be a significant drawback for businesses.

• Less privacy
  Unlike Delaware, California requires corporations to disclose the names of directors and officers in their annual Statement of Information. This may be less appealing for business owners who prefer to maintain their anonymity.

• Requirement for a board of directors
  California law requires that corporations with more than three shareholders must have at least three directors on their board. This could be burdensome for smaller businesses.

• Higher cost of living and operating costs
  California is known for its high cost of living, particularly in major cities, such as Los Angeles and San Francisco. This translates to higher operating costs for businesses, including higher wages and rent.

• Potential double incorporation costs
  If a business incorporates in California but then later re-incorporates in another US state, such as Delaware, the company would have to go through the incorporation process twice. This would lead to added expense and administrative effort.

Incorporating in Delaware vs California: Key differences

While no US state is objectively "better" for incorporation, deciding which state is the smartest choice for a business means understanding what sets each one apart. Here's a look at the key differences between incorporating in Delaware and California.

Corporate laws and legal system

• Delaware: Delaware has a well-established and flexible body of corporate law, which many consider to be the "gold standard" in US corporate law. The state's highly respected Court of Chancery focuses exclusively on business disputes, providing a streamlined and predictable legal process for corporations.

• California: California also has a robust body of corporate law, but it's generally viewed as being more protective of employees and shareholders than Delaware law. Unlike in Delaware with its Court of Chancery, California does not have a specialised business court, which could lead to longer and less predictable litigation processes.

Privacy

• Delaware: Delaware does not require businesses to list the names of officers or directors in the formation documents, providing businesses with a greater degree of privacy.

• California: California requires corporations to disclose the names of directors and officers in their annual Statement of Information, which may provide less privacy for these individuals.

Taxes and fees

• Delaware: all Delaware corporations must pay an annual franchise tax, which can range from US$175 to US$200,000, depending on the type and size of the corporation. However, if a corporation is formed in Delaware but does not do business there, it is not subject to state corporate income tax.

• California: California imposes a minimum franchise tax of US$800 on all corporations, regardless of income or activity level. If a corporation is based in California, it will also be subject to state corporate income tax.

Regulations and requirements

• Delaware: Delaware regulations tend to be business-friendly and offer flexibility in corporate structure and management. For example, Delaware allows one person to be the sole director of a corporation and hold all officer positions.

• California: California has stricter regulations and more requirements for corporations. For instance, corporations with more than three shareholders must have at least three directors on their board. California has also established diversity requirements for the boards of publicly held corporations that are headquartered in the state.

Legal environment and investor perception

• Delaware: many investors prefer Delaware corporations due to the state's flexible corporate laws and respected legal system. This can be especially advantageous for companies that are seeking venture capital investment or planning to go public.

• California: while California does not have the same reputation among investors as Delaware, incorporating in California can still provide credibility – particularly for businesses operating primarily within the state itself.

Cost of doing business

• Delaware: if a Delaware corporation does business in another state, it may have to qualify as a foreign entity, which could involve additional fees and paperwork.

• California: California has a higher cost of living and operating costs compared with many other states. This means that wages, rent and other business expenses could be higher in California than in Delaware.

Both Delaware and California offer advantages for corporations, but they also have distinct differences in their corporate laws, taxes and fees, privacy protections and business environment. The characteristics of each of these US states can affect different businesses in different ways.

How to decide which state to incorporate in

Deciding which state to incorporate in is a key step in the formation of a business in the US. Businesses should make this decision based on a comprehensive assessment of their needs, future growth plans, investor requirements and other important factors. Here is a general process that businesses in the US can follow to make this decision:

• Understand the business structure and future plans: a business's structure (sole proprietorship, partnership, LLC, corporation etc.) and future plans (i.e. attracting investors, going public or remaining privately held), can have a significant influence over where it should incorporate. For instance, venture capitalists and private equity firms often prefer investing in Delaware-based corporations due to the state's well-established corporate law system.

• Evaluate legal requirements and protections: businesses should understand the corporate laws of each of the US states that they're considering for incorporation. Some US states offer excellent levels of protection for directors and officers, while others may offer more protection for shareholders. As discussed earlier, Delaware's business-friendly laws and specialised Court of Chancery make it an attractive choice for many corporations.

• Consider privacy needs: if the business owners value privacy, they might prefer to incorporate in Delaware, given that it does not require businesses to publish the names of officers and directors.

• Assess tax implications: companies should consider the corporate tax requirements of each state. Some US states, such as Delaware, do not impose a state corporate income tax on businesses that don't operate within the state. Meanwhile others, such as California, have minimum franchise taxes regardless of income or activity level.

• Consider the cost and ease of doing business: this can include various factors, such as the cost of living, wage levels, property costs and the general business environment in the state. Businesses should also consider the ease of starting and operating a business in a particular US state, including the state's regulatory environment and bureaucracy.

• Seek legal and financial advice: consult with legal and financial advisors to get a full understanding of the implications of incorporating in a particular state and how it would affect your business and future plans.

• Factor in investor and market expectations: in some industries or for some businesses (e.g. those that intend to go public), market expectations might influence where a company incorporates. For example, in the tech startup world, many investors expect companies to incorporate in Delaware.

• Review and decide: after gathering and analysing all the information, business owners should review their findings, consider their options and make an informed decision about where to incorporate.