Tag Archives: delaware

The Delaware Freak-Out

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)


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.

Is Your Startup’s Name Available in Delaware?

Delaware has a pretty sweet Name Availability Search Tool via their Division of Corporations. If your desired entity name isn’t available to reserve, then that name isn’t available for a new corporate entity filing in Delaware. If your startup name is available, you can reserve the name online for $75.

Finding out whether you can reserve your desired corporate name in Delaware isn’t as exciting as landing a 5-letter domain with a domain registrar, but at least you don’t have to pay to search like other states.

Delaware is Suffering: Will Incorporation Fees Increase?

I’ve blogged before about the benefits of incorporating in Delaware. Thus, I was somewhat shocked to see the Deal Journal blog about how Delaware is becoming another victim of the credit crunch. I never thought about how much revenue Delaware receives from its Division of Corporations, but the article contained this statistic:

Delaware’s Division of Corporations contributed $700.8 million in revenue to the state in fiscal 2007. That was about 22% of the state’s total revenue.

According to Mark Roe, a Harvard Law Professor interviewed in the Deal Journal article, most of the Division of Corporations revenue comes from corporate franchise tax fees:

The current situation is that Delaware’s corporate tax base is eroding. On Delaware, it can have a big effect because Delaware gets about one-sixth to one-quarter of its state budget from corporate franchise fees.

Thus, If I’m reading the article correctly, Delaware doesn’t take in a lot of revenue from new incorporation fees. Delaware’s incorporation fees vary (click here for Delaware’s corporate fee schedule), but usually fall well below states like Texas which charges $300 for a new LLC or corporation. So will Delaware raise its incorporation fees to help make up the decreased Division of Corporations tax revenue?

The problem with raising incorporation fees is that Delaware needs to attract new filings, especially from out-of-state businesses. Raising incorporation fees would obviously not be a step in that direction. But it may be a better alternative, at least politically, than raising the state sales or corporate income tax.

And even if Delaware doubled or tripled its new incorporation fees, it wouldn’t affect a potential recommendation whether new startup company should incorporate in Delaware.

Flipping Your International Startup for U.S. Venture Capital

While the venture capital market becomes increasingly global thanks in part to Europe, China, Israel, India, and Canada, the United States remains the leader in venture-backed financing. Although some American venture funds are willing to invest in foreign startups, the lion’s share of U.S. venture funds are not going overseas.

Most U.S. venture capitalists believe ROI from domestic deals will be superior to foreign ones. Investing in a foreign company exposes the U.S. venture fund to a new set of legal rules, compliance issues, and risks, leading to increased uncertainty and transaction costs for the American venture fund. Additionally, trying to replicate typical American VC terms, such as anti-dilution and redemption provisions, can be difficult to accomplish in a foreign market.

Does this mean my international (i.e., Non-U.S.) startup will be shut out from a majority of U.S. venture capital funding or from being acquired by a U.S. company?

Potentially–unless your international startup performs a Delaware Flip Transaction.

What is a “Delaware Flip Transaction?”

A Delaware Flip Transaction is the process of creating an American holding company for an international company. The end result is that the international company will be owned entirely by the new American company. Thus, the U.S. venture fund will invest in the new American company.

What are the mechanics of a Delaware Flip Transaction?

The basic mechanics of a delaware flip transaction is to create a U.S. holding company and insert it above the international company. Next, the shareholders of the international company execute a share-for-share exchange by exchanging their shares of the international company for the shares of the U.S. holding company. (Note that this share-for-share exchange may require some additional legal maneuvering depending on the jurisdiction of the international company. For example, it will likely be necessary to use a “scheme of arrangement” or other court-approved process to accomplish the exchange in the UK and other jurisdictions.)

Why Flip to Delaware?

Delaware provides the most comprehensive set of corporate law in the United States. No matter which American state the venture fund is located in, such a fund will be comfortable with require Delaware law. Additionally, foreign companies are likely most comfortable with Delaware law, as Delaware provides a good neutral ground or “playing field.”

I previously wrote a post about why you should consider incorporating in Delaware here.

Final thoughts on Delaware Flip Transactions

Even if an American venture fund is willing to invest in (or purchase) your international startup, it still may be beneficial to perform the Delaware flip transaction. The reduction of legal uncertainty and the ability to replicate typical U.S. venture capital terms should dictate an increase in valuation and could facilitate a NASDAQ or other listing (although IPO exits for venture-backed companies are not very common). Alternatively, Delaware may provide neutral ground for funding or acquisition by a non-U.S. company or fund.

And finally, there are important tax implications that may result from performing a flip transaction, thus such a deal requires both U.S. and foreign accountants.

Thus, the Delaware flip transaction may not be for every international startup looking to be funded or acquired, but it should at least be considered.

Top 5 Reasons to Incorporate in Delaware

When you incorporate your startup company, two main decisions arise. First, what type of entity should your startup company be? Second, where should you incorporate?

Of the two, entrepreneurs focus primarily on choice of entity–LLC, Corporation, etc.–and usually just incorporate in their home state. And home state incorporation will make sense for most. But for a few startup companies, incorporating in a foreign state like Delaware, will be a better decision.

Delaware’s division of corporations lists 4 reasons to incorporate in Delaware on its website:

Why Choose Delaware as Your Corporate Home?

More than half a million business entities have their legal home in Delaware including more than 50% of all U.S. publicly-traded companies and 60% of the Fortune 500. Businesses choose Delaware because we provide a complete package of incorporation services including modern and flexible corporate laws, our highly-respected Court of Chancery, a business-friendly State Government, and the customer service oriented Staff of the Delaware Division of Corporations.

Talk about selling your state short. I’ll see their four reasons and raise them one. Thus, the following are my top five reasons to incorporate in Delaware:

1. Flexible Laws. Delaware’s General Corporation Law is the most advanced and flexible business formation statute in the United States. It is designed to provide maximum flexibility in the structuring of business entities and the allocation of rights and duties among founders and shareholders.

2. No Wildcard Juries. If you do end up going to court to settle a dispute, Delaware’s Court of Chancery uses judges instead of juries. I don’t know about you, but I’d rather place my startup company’s legal fate in the hands of a well-trained expert than people whose legal experience consists of The People’s Court and Law and Order re-runs.

3. Precedence = Less Litigation. Since judges are used, decisions are issued as written opinions that your startup company can rely on. Thus, most Delaware corporations do not end up litigating disputes because their professional advisers examine these published opinions and construct deals to avoid lawsuits.

4. It’s Free! (Well, almost). Delaware charges $89 to incorporate. A little bit cheaper than California ($100..but they nail you for $800 every year in franchise fees), New York ($125), and a lot cheaper than Texas ($300). [note: Even if you incorporate in a foreign state like Delaware, your startup company may still be subject to registration as a “foreign entity” and compliance with the laws of states you transact business in.]

5. Privacy. In a world where personal privacy is constantly eroding (the Google 3D Mapping truck should be driving by my house anyday now), Delaware does not require director or officer names to be listed in the formation documents. Thus, Delaware provides a level of anonymity from snoopers.

Even though this post makes a big push for incorporating in Delaware, you shouldn’t assume Delaware is the default choice for your startup company. The fact so many large, public companies choose Delaware should demonstrate that large, public companies tend to benefit the most from incorporating in Delaware.

So think about it and discuss incorporating in Delaware with your co-founders and professional advisers. But note that if you are planning to work with an investment bank or venture capital fund, you will likely have no choice but to become a Delaware entity. And for the five reasons above, that may not be such a bad thing.

Update: If you are looking for information about startup company incorporation, check out my “If I Launched a Startup” article.