Startup Formation – 4 Points to Consider When Deciding to Form Your Startup as a California or Delaware Corporation

Tim PoydenisTim G. Poydenis is an associate of the Firm and was formerly an associate of Stradling Yocca Carlson & Rauth, P.C. in Santa Monica.  Prior to Stradling, Tim was an associate and baseball sports agent at Beverly Hills Sports Council. Tim’s practice focuses on corporate matters, including venture capital financings, mergers and acquisitions, private equity transactions and general corporate and business matters.  Tim also advises emerging growth and development stage companies on entity formation, corporate governance and day-to-day corporate matters.

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A preliminary (legal) question that startup companies typically want answered is where they should form their startup entity.  With the rise of “Silicon Beach” in the LA market, this question often arises in the context of whether a company that has set up shop in LA should form a California or Delaware corporation.[1]  There are several items to consider in answering this question and while there is often no “right” or “wrong” answer, here are four common discussion points.

  1. Certainty in Law:

The Delaware General Corporation Law (“DGCL”) is a current and internationally recognized corporation statute that is frequently updated to account for new legal and business developments.  In addition, Delaware has well-developed case law that has been authored by top judges in the field.  Aside from the readily apparent benefits of the foregoing (e.g., a corporation being able to guide its formation and activities consistent with the DGCL and developed case law), litigation related to a Delaware corporation’s corporate activities is often less likely to occur than with a California corporation as the DGCL and past Delaware case law likely already address a substantially similar dispute or issue that may arise (and thus litigation may be unnecessary).  Accordingly, Delaware edges out California with regard to this point.

  1. Investor and Buyer Preference:

Whether it is early in a startup’s evolutionary path with raising money from friends and family, late round financings, or an eventual exit, potential investors and buyers typically prefer that a company be formed as a Delaware corporation. Delaware is preferred for many reasons that include, but are not limited to: the DGCL is an internationally recognized business corporation statute that is updated regularly; there is well-developed case law analyzing various provisions of the DGCL; the Delaware Court of Chancery is considered by many to be the leading business court; and, simply put, most investors and buyers are more comfortable with a Delaware corporation since they are likely accustomed to seeing Delaware corporations in transactions rather than California corporations.  As a result, potential investors and/or buyers may require that a California corporation convert to a Delaware corporation as a condition precedent to the funding of an investment or a closing of an acquisition.  Although the conversion mechanics are not overly burdensome, it is often better to have a Delaware corporation from the outset to avoid additional hurdles and/or action items to process that may later delay the closing of a needed financing or pending acquisition.

  1. Efficiency of the Secretary of State:

The Secretary of State of the State of Delaware is generally thought of as the most efficient secretary of state in the US.  From same-day filings, to expedited one-hour or two-hour filings, to a customer friendly and knowledgeable support staff, the Secretary of State of the State of Delaware takes away many of the (potential) miscues or headaches associated with transactions that may result from requests directed at the applicable secretary of state.  This is not to say the Secretary of State of the State of California does not offer similar services and expertise (which it does), but the general consensus is that the reliability and speed of the Secretary of State of the State of Delaware is preferred.

  1. “Quasi California Corporation

Notwithstanding the fact that a corporation may be formed in Delaware, a Delaware corporation may be subject to certain provisions of the California Corporations Code (the “CCC”).  Section 2115 of the CCC provides that certain provisions of the CCC may apply to a foreign corporation (e.g., a Delaware corporation) if certain factors are met.  One of the factors set forth in the CCC is an assessment of whether more than one-half of the outstanding voting securities of a corporation are held of record by persons having addresses in California, which is often the case with Silicon Beach startups.  This is not to say that a California-based company should incorporate in California if the factors of Section 2115 of the CCC will be met, but this is just another item to consider when determining the appropriate state of formation.

                As highlighted above, there is often no “right or “wrong” answer when it comes to picking the appropriate state of incorporation, but there are many items to discuss (well beyond the 4 highlighted above) with your business, legal and/or tax advisors.

[1]               Please note that the discussion points in this article are limited to Delaware and California corporations.  Information regarding additional jurisdictions and/or entity types available upon request.

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This article is intended for informational purposes only and does not constitute legal advice.   For more information regarding your legal needs, contact Tim Poydenis at tpoydenis@stubbsalderton.com or (818) 444-4547.

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