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The Delaware Freak-Out

Posted 04 Jan 2010

The New Year. For some, it’s time to reflect on the past and look forward to the future. For others, it’s time to make resolutions to change for the better. But for me, it’s time to respond to client inquiries regarding their 5-figure Delaware annual franchise tax bill due March 1.

Authorized Shares Method

Delaware sends out their franchise tax bill invoices based on the number of shares the startup corporation has authorized, known as the “Authorized Shares Method”:

-$75 for 1-5,000 shares;
-$150 for 5,001 – 10,000 shares; or
-$150 PLUS $75 for each additional 10,000 shares (or portion thereof) above 10,000 shares.

Thus, if your startup authorized 10,000,000 shares, your startup’s DE tax bill will likely be $75,075. Not exactly a number a bootstrapped startup wants to see, right? Thankfully, there is an alternative way to calculate your startup’s DE franchise taxes–and one that is very likely to lead to a much lower tax bill.

Assumed Par Value Capital Method

Instead of using the Authorized Shares Method, a Delaware startup can choose to have its annual franchise taxes calculated using the “Assumed Par Value Capital Method.” In this method, your startup’s Delaware franchise tax bill is calculated based on all issued shares, authorized shares, and total gross assets in the following manner:

Step 1: Divide Total Gross Assets by Total Issued Shares (“Assumed Par Value”)
Step 2: Multiply Assumed Par Value by Total Authorized Shares (“Assumed Par Value Capital”)
Step 3: The franchise tax is calculated at $350 per every $1,000,000 or portion thereof of Assumed Par Value Capital.

Here’s an example of a calculation of a startup with total gross assets of $250,000, 5,000,000 issued shares and 10,000,000 authorized shares:

Step 1: $250,000/5,000,000 shares = $0.05 Assumed Par Value
Step 2: $0.05 * 10,000,000 shares = $500,000 Assumed Par Value Capital
Step 3: $350 * ($500,000/$1,000,000) = $175.00 Franchise Tax

(Note: The example assumes the startup’s actual par value on its shares (i.e., in the charter) is lower than the assumed par value. Otherwise, the actual par value is used in place of the assumed par value in Step 2 above)

Conclusion

Most startups will benefit by using the Assumed Par Value Capital Method when calculating its Delaware Franchise Taxes. The problem is that your startup isn’t given this option until it actually logs on to the Delaware state site to file and pay the annual franchise tax.

Here is a link to a Delaware Franchise Tax Calculator. Here is a link to FAQ regarding Delaware Taxes.

UPDATE: Delaware increased its minimum franchise tax using the assumed par value capital method to $350.

18 Comments
  • Chris
    Posted at 01:24h, 22 March Reply

    What other fees should I expect to pay for having a Delaware corporation versus just the franchise tax? I understand that I have to pay about $100 for having a person in the state that can receive any summons against the corporation. Anything else?

    I'm also wondering how long it will take to incorporate in Delaware and then get the right to do business in Texas, vs just incorporate in Texas to begin with?

    Thanks a lot!

  • Chris
    Posted at 20:24h, 21 March Reply

    What other fees should I expect to pay for having a Delaware corporation versus just the franchise tax? I understand that I have to pay about $100 for having a person in the state that can receive any summons against the corporation. Anything else?

    I'm also wondering how long it will take to incorporate in Delaware and then get the right to do business in Texas, vs just incorporate in Texas to begin with?

    Thanks a lot!

  • Ryan Roberts
    Posted at 08:41h, 22 March Reply

    That should be it re fees. The difference in time is nominal for a DE + TX incorporation than just a TX incorporation.

  • Ryan Roberts
    Posted at 03:41h, 22 March Reply

    That should be it re fees. The difference in time is nominal for a DE + TX incorporation than just a TX incorporation.

  • Ranjan
    Posted at 01:42h, 31 May Reply

    am trying to come with a reasonable estimate for my franchise tax fees using the assumed par value capital method. For software companies like a web service that I want to offer to customers, I am considering the software itself as asset for my tax calculations. Would that be correct. If I can use software as an asset, how do you come up with a dollar value for the asset? I have used this tool – http://www.dwheeler.com/sloccount/ but don't know if there's other accepted standard metrics for coming up with an asset value in such cases. Awsome blog BTW. Thanks,

  • Ranjan
    Posted at 20:42h, 30 May Reply

    am trying to come with a reasonable estimate for my franchise tax fees using the assumed par value capital method. For software companies like a web service that I want to offer to customers, I am considering the software itself as asset for my tax calculations. Would that be correct. If I can use software as an asset, how do you come up with a dollar value for the asset? I have used this tool – http://www.dwheeler.com/sloccount/ but don't know if there's other accepted standard metrics for coming up with an asset value in such cases. Awsome blog BTW. Thanks,

  • Trevor
    Posted at 18:42h, 09 September Reply

    Isn’t step 3 in Assumed Par Value Capital Method more correctly calculated as $350 for your example, not $175?. I didn’t think the tax could drop below $350, since it reads “or portion thereof”.

    Thanks for writing this by the way.

  • Austin
    Posted at 17:44h, 16 September Reply

    Great post, but that last part scares me when you say “The problem is that your startup isnt given this option…” Why is this a problem? Is it possible that you could get taxed the 75,000 for the first year?

  • Anonymous
    Posted at 18:02h, 16 September Reply

    A startup isn’t likely aware of the lower option until they log on — if they just open their letter and send a check, they could miss out on paying $75.

  • San
    Posted at 14:35h, 31 January Reply

    Our par value is much greater than the assumed par value, and our franchise tax is therefore ridiculous high. Is there any way we can retroactively set a lower par value, or somehow elect to use the assumed par value instead?

  • Doug
    Posted at 13:38h, 15 February Reply

    I logged on to pay my Franchise tax and used the form & calculator. I could not get the tax below $350. Then I read on Delaware’s site (The minimum tax for the Assumed Par Value Capital Method of calculation is $350.00.) What did I miss?

  • Stefan Wrobel
    Posted at 01:06h, 21 February Reply

    Doug, Delaware changed the policy on August 1, 2010 so the minimum for using the assumed par value method is $350 even if the calculation yields less. I guess too many people were paying little to no tax under this method and they needed the revenue.

  • We issued too many shares when incorporating in Delaware. What should we do? Our franchise tax is very high. - Quora
    Posted at 01:27h, 30 March Reply

    [...] a great discussion of this by Ryan Roberts on his blog entitled "The Delaware Freak-Out": http://startuplawyer.com/incorpo…Antone Johnson • 11:27pmView All 2 CommentsCannot add comment at this time.  Charles [...]

  • Oliver
    Posted at 18:12h, 19 December Reply

    Ryan, is there a safe/target number of shares you’d recommend to issue in conjuntion with incorporation? For the first round most founders want to issue $0.01 par value common to set the price for their ISO pool, so assuming the founder puts in $200,000 in cash/assets, that is 20 million issued common shares. Should another 20 million be authorized for future grants, equity, and options? Total would be 40 million, which seems pretty high, but the taxes aren’t bad if you use Assumed PV Capital Method. I’m sure every founder is curious about this. Thanks and Merry Christmas.

  • Oliver
    Posted at 18:29h, 19 December Reply

    One more founder-type question. Do you know what the actual law/SEC ruling is on the cooling off period between financings? I’ve had attorney friends tell me different things, or have no idea. I thought it was six months between financings or the SEC can lump the financings together and make you blend/recalculate a weighted average price for your shares. Again, I think this question will help a lot of people because it affects the mandatory time period between seed and series A rounds. Thanks again for the great blog.

  • Delaware Franchise Taxes | Startup Lawyer
    Posted at 15:46h, 06 January Reply

    [...] was the topic of a post I wrote 2 years ago titled “The Delaware Freak-Out.” If you have a startup that is incorporated in Delaware, it’s probably a good time to [...]

  • Ariel Azoff
    Posted at 16:18h, 11 April Reply

    Hi – for a startup about to form an LLC, would you recommend Delaware? I’m getting different opinions on this. (Apologies if you have a post on this somewhere that I didn’t find.)

  • Richard Newhagen
    Posted at 18:02h, 24 February Reply

    Ryan, with regards to the Total Gross Assets, if a Delaware C Corp has foreign subs, are the assets of the subs included in the calc, or is it just the U.S. entity’s assets that are included?

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