Incorporating in Delaware vs. California: Pros, cons, and how to decide

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  1. Introduktion
  2. Benefits of incorporating in Delaware
  3. Benefits of incorporating in California
  4. Potential downsides of incorporating in Delaware
  5. Potential downsides of incorporating in California
  6. Incorporating in Delaware vs. California: Key differences
    1. Corporate laws and legal system
    2. Privacy
    3. Taxes and fees
    4. Regulations and requirements
    5. Legal environment and investor perception
    6. Cost of doing business
  7. How to decide which state to incorporate in

Deciding where to incorporate is an important decision that can have lasting effects on your 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 have made Delaware their legal home. This includes many Fortune 500 giants, who often favor 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 $1 billion).

In choosing between Delaware and California, 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’ll help guide you through this process by covering the distinct advantages and disadvantages of incorporating in each state.

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 nation. The state’s laws are generally favorable to businesses and offer flexibility around 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 specializes in corporate matters and uses judges—not juries—to make decisions. This court is highly respected and boasts a rich case law specializing in business matters. This means that the court has already addressed many legal issues through the years, providing greater predictability and legal stability for businesses. The judges in the Court of Chancery are appointed on merit, which helps contribute to the court’s high level of expertise in corporate law.

  • Privacy protections
    In Delaware, corporations are not required to disclose officer or director names in the formation documents. This provides corporations with a level of privacy not available in all states.

  • Tax advantages
    Delaware does not impose income taxes on corporations based in other states or 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 favor 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 favorable 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 resolve complex legal issues in a faster and more predictable way than in states with less developed corporate case law.

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 your business is physically located in California and you plan to operate in the state primarily, incorporating in California could be advantageous. This can make compliance easier, and it can cut down on fees and paperwork since the business won’t need to qualify as a foreign entity to do business in California.

  • Credibility and recognition
    Just like incorporating in Delaware, incorporating in California can provide businesses with a sense of credibility and legitimacy—especially those that operate within the state. Customers, suppliers, and investors might see a California corporation as 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 you plan to conduct the majority of your business within the state. The company will be subject to California law, making legal guidance more straightforward and localized.

  • 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 to 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 $175 for most corporations, but it can go up to $200,000 for larger entities. In addition, Delaware corporations must also pay an annual report fee of $50.

  • Costs of operating in another state
    Typically, if a Delaware corporation conducts business in another state, it is considered 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 specialized 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 might view Delaware incorporation 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 states.

  • Shareholder lawsuits
    While Delaware’s laws are generally friendly toward management, the state is also known for shareholder litigation. The state’s developed body of law and specialized 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 $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 areas such as environmental standards, labor 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 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 reincorporates in another 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 state is objectively “better” for incorporation, deciding which state is the smartest choice for your business means understanding what sets each state apart. Here’s a rundown of the key differences between incorporating in Delaware and California.

  • Delaware: Delaware has a well-established and flexible body of corporate law, which many consider 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 more protective of employees and shareholders than Delaware law. California does not have a specialized business court such as Delaware’s Court of Chancery, which could lead to longer and less predictable litigation processes.

Privacy

  • Delaware: Delaware does not require businesses to list officer or director names 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 $175 to $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 $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 headquartered in the state.

  • 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 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.

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 to 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. Each state’s characteristics can impact 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. The decision should be based on a comprehensive assessment of the business’s needs, future growth plans, investor requirements, and other important factors. Here is a general process businesses can work through 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 significantly influence 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 state they’re considering for incorporation. Some states offer greater protections for directors and officers, while others may offer more protection for shareholders. As discussed earlier, Delaware’s business-friendly laws and specialized 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 since 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 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 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 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 analyzing all the information, business owners should review their findings, consider their options, and make an informed decision about where to incorporate.

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