Editor’s note: Opinions expressed in this commentary are the author’s alone. This article is general in nature and does not constitute legal advice. Readers with legal questions should consult an attorney.
Entrepreneurs often think they need to incorporate in Delaware. In this article, we’ll look at whether that is the best decision (hint – often it’s not).
What it means to “Incorporate”
To “incorporate” means to form a corporation. If you are forming an LLC, your state may call that an “incorporation” too, or they might call it an “organization” or “formation” or something else. When you form a corporation or LLC, the state will issue Articles of Incorporation or a similarly titled document. This is kind of like a birth certificate for your business.
(What about S-Corps? Well, S-Corps are not a business entity. Read more here.)
Where to Incorporate
Entrepreneurs in the U.S. can incorporate their business in any state in the union. In most cases, you will incorporate in the state in which you live or do business. However, some entrepreneurs incorporate in Delaware. Here are some tips on helping you decide.
1. Formation Fees
Every state charges a fee to incorporate. Generally speaking, they are not very high and since they are only a one-time fee, you shouldn’t base your state of incorporation solely based on this.
Missouri charges $58 for corporations — although that number can increase based on the value of your authorized capital — and $50 for LLCs. Kansas charges $85 for corporations and $160 for LLCs. Delaware charges $89 for corporations and $90 for LLCs. Seriously Delaware, a $1 difference!
2. Annual Reports & Fees (including Franchise Taxes)
Missouri, Kansas, and Delaware each require some form of Annual Report and annual fee for corporations (sometimes called a Franchise Tax). The cost in Missouri and Kansas is minimal – between $20 and $55. But in Delaware, the minimum fee is $225 and can be substantially higher based on how your corporation is structured.
For LLCs, both Kansas and Delaware have annual report fees, $20 for Kansas and $300 for Delaware. But in Missouri, you don’t have to file any ongoing annual reports for LLCs. That is a really nice perk for filing in Missouri.
You might also want to consider corporate income taxes, but you really should talk to an accountant about how that will impact your decision.
3. Operating in Foreign States
If you operate in a state other than where you incorporate, then you must usually get authorization from that state to do business there. For example, if you are a Delaware corporation operating in Missouri or Kansas, you will have to file reports in and pay fees to Missouri or Kansas — including annual reports. While not determinative by itself, this is obviously a reason to incorporate in Missouri or Kansas if that is where you’ll be running your business.
4. Statutes, Secretaries of State and Court Systems
Each state maintains its own laws regarding corporations and business entities and obviously, each state has its own Secretary of State office and a court system. What you should know is that they are all different. Delaware is generally better on all those fronts for business owners, but as between Delaware and Missouri/Kansas, the difference is not overly significant except in certain areas.
Because so many businesses are incorporated in Delaware, like two-thirds of Fortune 500 companies, investors tend to like businesses incorporated in Delaware. They appreciate the reduced risk that comes from issue number four above. However, this is not an iron-clad rule and many investors will invest in companies incorporated outside of Delaware provided the business is properly structured.
What should a Kansas City startup do?
Most of our clients incorporate in Missouri or Kansas. There are a number of reasons for that. First, many of the benefits of incorporating in Delaware simply don’t apply to our clients. And second, for early-stage Kansas City startups, the advantages of incorporating in Missouri or Kansas outweigh the advantages of incorporating in Delaware. Plus, if the startup grows and there is a need to incorporate in Delaware, you can achieve that through a merger, asset sale, or some other means.
Of course, every situation is unique and you should get legal and accounting advice regarding your business’ situation before making decisions. If you have questions, you can contact us.
Chris Brown is the founder of Venture Legal, a Kansas City law firm serving the entrepreneurial community, and also b.Legal Marketing, a website development and hosting platform for small law firms. You can follow him on Twitter @CBSCounsel. Sign up for more stories like this by clicking here.