SHOULD I INCORPORATE IN DELAWARE OR ILLINOIS?

Many businesses decide to incorporate in Delaware, but new businesses shouldn’t assume that Delaware’s popularity automatically makes it the best place to incorporate. If you’re launching a new Illinois-based business, you should thoroughly understand the pros and cons of incorporating in Illinois versus Delaware before making a decision.

Understanding Delaware’s Popularity

There’s no denying Delaware’s popularity among corporations. As of April 2014, 65.6 percent of Fortune 500 companies (Don’t forget these are billion dollar corporations with many risks at hand) used Delaware as their corporate domicile, and that percentage is slowly but steadily increasing. What’s the appeal of incorporating in Delaware? There are many:

  • The initial cost of incorporating in Delaware is as low as $89 and the annual franchise tax is as low as $175. It’s cheap!
  • The Delaware Court of Chancery – which focuses on corporate disputes – is particularly well respected and knowledgeable about Delaware’s General Corporate Law. The court only has bench trials, no juries, meaning litigants frequently get decisions in the form of written opinions which help further shape Delaware business law and create predictability. (*) please read notes below about this matter. Many States, including Illinois have duplicated the Delaware Corporate Laws making DE not as attractive as before.
  • Because so many corporations are domiciled in Delaware, the state takes seriously its responsibility toward its corporations. Delaware’s General Corporate Law is business-friendly and Chancery Court written opinions mean there’s a lot of legal precedent.
  • At the same time, the state’s business statutes give companies a lot of flexibility in terms of organization, shareholder rights, and board rights and responsibilities.
  • Investment bankers, venture capitalists and angel investors prefer companies incorporated in Delaware.

 

Deciding Between Illinois Incorporation & Delaware Incorporation

There are many good reasons to incorporate in Delaware, but one size doesn’t fit all. Illinois-based businesses should first consider the advantages of incorporating in Illinois. You’ll want to take into account cost considerations, tax considerations and jurisdictional considerations.

Cost considerations: Incorporating in Illinois costs $150 plus an initial franchise tax of $1.50 per $1,000 of paid-in capital. The minimum initial franchise tax is $25. Regardless of where you incorporate, you’ll also have to have a registered agent in that state for service of process. If your business is based and incorporated in Illinois, then you won’t have to pay for a registered agent; you or another employee can act as the designated registered agent. However, if your business is incorporated in Delaware but has no physical presence there, then you’ll pay a Delaware registered agent a couple hundred dollars annually. Additionally, if you incorporate in Delaware but are doing business in Illinois, your company must also register in Illinois (as a foreign entity doing business in this state), meaning you’ll have to pay the Delaware annual report fee plus the Illinois annual report fee. Finally, if you incorporate in a state outside of where your company is based and operating, then you may have to hire both Delaware- and Illinois-based business lawyers when legal issues arise.

Tax considerations: Depending on the size and corporate structure of your business, as well as the states in which your business has a physical presence, your company will be subject to a variety of taxes. In addition to the annual franchise tax, these can also include income taxes, sales taxes and withholding taxes. Before making an incorporation decision, you should consult with a business lawyer and an accountant to get a side-by-side comparison of your annual estimated tax bills should you chose to incorporate in Illinois or another state.

Jurisdictional considerations: Simply put: Your Corporation is bound by the laws of the state in which it is incorporated. That means you’ll want to consider a few factors when evaluating the jurisdictional issues related to incorporation. (*) In the last decade a number of states (including Illinois) have modeled their business laws after those of Delaware. But you’ll still want to work with lawyers to determine whether one state has more favorable laws for the business structure you’re considering. Also, realize that if your company is sued, the laws of the state in which you’re incorporated will apply to any jurisdictional issues in the case. (*) In other words, if your company is incorporated in Delaware, but is sued in Illinois, then Delaware’s laws will come into play; this can add to your legal fees because your attorney will have to research applicable laws in both Illinois and Delaware. If you incorporate in Delaware and are sued there, that can result in a lot of time lost when traveling to and from Delaware, as well as higher travel costs. And it may cost more to hire Delaware corporate lawyers versus Illinois corporate lawyers.

When Illinois Incorporation Isn’t the Best Choice

For many Illinois businesses, the total cost of a long-distance Delaware incorporation outweighs the benefits gained from incorporating in the Diamond State. However, when counseling new businesses, there are a couple specific situations when we do recommend a Delaware incorporation.

The first is if your business falls into a high-risk category (Airplanes, Medical devices Pharma, Guns, etc. …) )Delaware’s liability laws may offer greater protections, compared to Illinois, for officers and directors. (*) But please do not forget that if a Corporation is sued in a state where it provides its services, the Delaware Corporate laws will not take precedent over the local State Laws. This is something that many if not all founders and business owners forget! (You will be sued in both States! and the legal case will take precedent on where the damages incurred!)

We also recommend Delaware incorporation to companies looking for large outside investors (C, D or E Rounds) or mezzanine financing via syndication or PE, as well as for companies that are anticipating an IPO.

The Bottom Line

Don’t act too hastily when deciding where to incorporate your start-up business. Founders should consult with corporate attorneys and tax advisors to fully understand the pros, cons, costs, tax ramifications and potential liabilities when deciding not only the state of incorporation but also the optimal business structure for their new company.

This article constitutes attorney advertising. The material is for informational purposes only and does not constitute legal advice.