Why So Many Companies Choose to Incorporate in Delaware

By Anthony de Freitas | Friday, 09 April 2021 | Feature, Business

When it comes to selecting a residence, many companies choose the US state of Delaware. Some of the largest domestic companies are incorporated there, including Google and its holding company Alphabet (and, of course, DuPont). The state has also attracted foreign businesses. Around 80% of the companies on Delaware’s registers are located outside the United States — a list that includes COVID-19 vaccine maker AstraZeneca, which has set up its US headquarters in the state.

What is it that has drawn these companies to Delaware? We’ll attempt to answer that question in what follows. Nonetheless, if you’re contemplating a Delaware incorporation or forming a Delaware LLC, consult your CPA or an attorney familiar with Delaware business entity laws.

Delaware: Home to Many Fortune 500 Companies

In the corporate world, all roads seem to lead to Delaware. Recent state data shows that, presently, more than two-thirds of Fortune 500 companies are incorporated in Delaware. By the end of 2019, the latest year for which data is available, close to 1.5 million legal entities had chosen the state as their registered location. It was a year that saw about a quarter of million business entities being formed in the First State. Delaware also seems to be a good place for companies going public. In 2019, about 90% of US companies that had IPOs chose Delaware as their headquarters.

It wasn’t always that way. Up until the early 1900s, the favored state for companies that wished to incorporate was New Jersey. Among them was the Delaware company DuPont. This prompted the Delaware legislature to entice DuPont to reincorporate where it was founded by passing laws similar to the Garden State’s. DuPont did reincorporate in Delaware and, within two decades, Delaware had established a reputation as a haven of corporate formation, which it has retained to this day.

How did Delaware achieve such a dominant position and stature in the market for corporate formations? The tiny state has less than a million residents, placing it in 45th position in a population ranking of US states. Delaware’s economy is not that big either; it is the nation’s 42nd largest.

The state’s reputation as a first-rate location to incorporate or form a business entity is founded on some distinctive attributes. Notably, despite differences on a host of other issues, legislators on both sides of the aisle remain united on maintaining Delaware’s preeminence as the place to incorporate. This has ensured the state’s business laws remain responsive to change. Administrative procedures for creating business are speedy, while personal and corporate tax rates are low. A special court, established in the 1790s, deals solely with corporate matters. Disclosure requirements are relaxed, and some entities need not disclose their owners or managers.

Delaware Is Corporation-Friendly

Since passing the Delaware General Corporation Law in 1899, the First State has actively promoted itself as the place for businesses to incorporate. In the 19th century, there were three dominant business forms: sole proprietorship, partnership, and corporation. Forming a corporation was the only form that gave owners limited liability, restricting their liability to the amount they had invested in the business. If you were a sole proprietor or member of a partnership, creditors could go after your personal assets to satisfy business debts.

But forming a corporation was not easy. Incorporation generally required special legislative approval. No state had a law that permitted incorporation by registration. The one that came closest was New York’s Act Relative to Incorporations for Manufacturing Purposes of 1811. But only manufacturing enterprises were eligible.

Almost a century was to pass before New Jersey, attempting to attract “incorporating” business that was going to the Empire State, passed an “enabling” corporations law. The law was “enabling” because it allowed a commercial corporation to do many things that commercial enterprises, up to that time, were not permitted to do. Soon after, Delaware followed with its own corporation law.

Critics were horrified at its provisions, which today are standard fare. The statute allowed “any lawful business except banking” to be incorporated, a bitter pill they may have swallowed if the law did not permit further heresies. It allowed a corporation to conduct business anywhere in the world and bestowed it with immortality (i.e., perpetual existence). Nonetheless, those very non-conformities gave Delaware the edge in corporate formation, particularly after New Jersey rolled back some of its corporation enabling rules.

Those business-friendly enabling rules keep evolving. There are no nationality or residence requirements on stock or membership interests in a Delaware company. A resident of another state or country can form a Delaware business entity. However, every entity must have a registered agent that has a physical street address in Delaware. The registered agent may be either an individual resident or business entity that is authorized to do business in the State of Delaware. The business may act as its own registered agent if it is physically located in Delaware. In 1991, the state passed its first Limited Liability Company Act, which extended the same favorable treatment to LLC formation as Delaware’s General Corporation Law (GCL) did to corporate formation.

Delaware law also allows a simple governance structure for a business entity. In a corporation, one person—the founder, perhaps—can wear several hats. He can be the president, secretary, and treasurer, as well as the only director and the sole shareholder. This allows a small business that is, in essence, a sole proprietorship to enjoy the benefits of corporate status.

Delaware Law: Consistent, Up-to-Date, and the First for Series LLCs

The Delaware legislature takes pains to ensure its General Corporation Law (GCL) is an island of stability. To amend the GCL, a supermajority vote is required. Accordingly, changes to the GCL are less affected by the proposals of special-interest groups or influential corporations, which provides consistency and makes the law the basis of a more level playing field for all corporations.

Authorities are highly responsive to the changing business environment, as well as the views of the academic and professional communities. For instance, the state was the first, in 1996, to authorize the creation of a Series LLC, which it did at the behest of prominent Delaware attorneys. 

Series LLC

A series LLC is a special type of LLC where the articles of formation allow membership interests, assets, operations, and most importantly liability, to be segregated into separate legal entities. A “series” can be likened to a subsidiary in a corporate structure and should have a unique name, keep separate records, and have its own bank account. Similar to the unique bylaws of a corporate subsidiary, a series LLC has its own operating agreement. Also like a subsidiary, it may also have separate management and a variety of owners.

Delaware Court and Legal System

Delaware’s legal system—its judges and legal practitioners—are held in high regard, both at home and abroad, because of the speedy rulings of its courts. For matters involving business entities, the state has a special court, the Court of Chancery, which dates its existence back to 1792. As a result, an extensive body of case law stretching over two centuries is available to resolve disputes. A separate court for business matters also means that the progress of such cases through the court system is not impeded by the traffic of non-business issues.

Delaware Tax Advantages

There are tax advantages to incorporating in Delaware. Corporations that do no business in the state are not subject to income tax. Additionally, non-resident shareholders don’t have to pay tax on shares.

The state does impose income and franchise tax on corporations as well as taxes on LLCs. Corporate income is taxed at a flat rate of 8.7% of taxable income originating in Delaware. The franchise tax may be calculated in two ways: the Authorized Shares Method and the Assumed Par Value Capital Method. The Authorized Shares Method is a flat fee of $175 to $250 for 10,000 shares or less, plus $85 for every additional 10,000 shares. The Assumed Par Value Capital Method is a flat fee of $175 to $250 for $1 million or less of assumed no-par value capital, plus an additional fee of $400 per million (or portion of a million).

Corporations that elect S corporation (S corp) status are exempt from income tax; the owners are taxed instead. However, an S corp must still pay the franchise tax. Instead of these taxes, LLCs are required to pay an annual tax of $300.

Delaware has graduated personal income tax rates that range from 2.2% to 5.55% on income under $60,000. The maximum income tax rate is 6.60% on income of $60,000 or over.

Anonymity for Stakeholders

Privacy is another reason entrepreneurs choose Delaware for setting up a corporation or LLC. Shareholders of a corporation and members of an LLC have the option to remain anonymous. In line with other US states, Delaware does not require the names of beneficial owners — the natural persons who ultimately own, control, or derive benefits from a company — through the incorporation or formation process.

However, a corporation’s directors must be made public. Their names appear on the compulsory annual report that all Delaware corporations must file. In the past, corporations achieved anonymity by simply not filing the report. Failure to do so resulted in a small fine ($100 max) and the possibility of being “investigated” by the state Attorney General, a small price to pay for going incognito. That is no longer so. Delaware law now states that corporations failing to file a complete annual report will not receive a certificate of good standing — an indication that the corporation is a legally valid company and authorized to conduct business.

All That Glitters May Not Be Gold

Despite all its virtues, incorporating in Delaware is not for every business. Companies incorporated in Delaware may not be taxed if they don’t do business in the state. Nevertheless, they will still be taxed in their home states.

Filing fees are generally higher. In particular, the franchise tax can increase considerably if your business does well and your share values go up. You will also still need to meet your home state's filing and licensing requirements if you conduct business there, meaning you may be required to file annual reports in both locations, doubling your paperwork and costs.

If you are not physically present in Delaware, there will be an additional fee to hire a registered agent that will handle legal filings and other matters for your business. If there are any legal disputes to resolve, you will likely be required to travel to Delaware. Cases involving Delaware companies are unlikely to be adjudicated anywhere other than a Delaware court.

Delaware offers many advantages to large corporations if they live there. For smaller companies, the benefits are not so obvious.

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