As a lawyer, I would have to say that you should do it by the book and dissolve the entity. I have, however, had a variety of clients over the years who left a Delaware corporation to die without dissolving it and they have not had trailing personal liabilities as a result of the accrued corporate franchise taxes (of course, it is a different matter if the corporation earned a net profit and has an obligation to file income taxes - in that case, failure to file can cause serious problems for the corporation and for its management).
The $89K tax bill is typical of any Delaware corporation that has large numbers of authorized shares, even with a low par value. This often proves a shock to unsuspecting founders who file a do-it-yourself entity without understanding the issues. However, in almost all cases involving an early stage startup, you can deal with this easily by using the alternative valuation method tied to value of assets in the company. Use of the alternative method usually reduces the franchise tax to a very low level. It is easy to find out how to use the alternative method (forms and instructions are available online through the Delaware Secretary of State).
It seems that you needed to set up the entity in order to try to manage the issues with your co-founder and so the choice to set up a corporation was not really a mistake. The choice to set it up in Delaware for a simple situation can be a mistake, in my judgment, but I am probably in the minority among startup lawyers on this issue in believing that a home-state incorporation in the interests of keeping things simple can be and often is the best choice for founders (see http://grellas.com/faq_business_startup_002.html). It is no disgrace for a Silicon Valley startup to incorporate in California, even for a public company (no less than Apple itself is a California corporation). Had you done a home-state incorporation, you would have avoided the hassles with the $89K tax bill, as most states besides Delaware states have a fixed, low amount that you pay every year as a minimum franchise tax (in California, $800).
Incorporation is definitely not for everyone. When and if to incorporate can be tricky questions. I also have outlined a few of the factors to guide that decision as well (http://grellas.com/faq_business_startup_007.html).
There are a good number of early-stage startups that really can't easily afford professional fees and so the answer is not to use a lawyer in all cases to incorporate. But, even if you can't afford a lawyer, it is always worth consulting with one for strategic advice on incorporating before you do so. Such a first consultation is dirt cheap in most cases, and sometimes free. The modest amount paid is well worth it just to be alerted to the main issues and pitfalls involved in setting up an entity. Thus, while it was probably not a mistake in itself to set up your corporation, it likely was a big mistake to do so without some guidance of this type (I had made this comment in connection with your original piece as well - http://news.ycombinator.com/item?id=1924719).
Sorry to hear about the business failure. I know the HN community often stresses what a valuable learning experience this can be but there is no denying that it is a very painful affair by any measure.
The CA tax is waived in just a few cases. For example, some types of corporations (not LLCs) are exempt in the first year, and an LLC that is dissolved before the first year and meets other requirements may also be exempt.
Disclaimer: I am not a lawyer.
(Also, we're lucky to have contributors like grellas in the HN community. Thanks.)
The franchise tax for foreign corporations is heavily dependent on having a physical nexus to California, such as offices, employees, or equipment located within California borders. For example, registering as a Nevada company but headquartering in Santa Monica would result in the imposition of a franchise tax. While this situation is quite common, it usually has the nasty side effect of subjecting the business to nasty tax penalties for not paying franchise taxes they thought did not apply.
The franchise tax is waived for domestic S-Corporations in their first year of existence, unless they are profitable. LLCs are required to pay the franchise tax whether or not they dissolve in the first year unless they were never a going concern (i.o.w., they never actually did any business).
I believe that at least at one time (early '90s, when I got this information from my corporations professor in law school--maybe it is different now), Delaware was basically a rocket docket for complex corporation cases, such as shareholder lawsuits against large public companies. That was one of the attractions of them for large public companies, which might be worth adding to your FAQ. Who wants their cool merger delayed by many years over a suit from grumpy shareholders?
(I couldn't find the original, less biased account, but it's been well documented)
My limited company has cost about £50 in administration and set-up fees so far. But the cost of learning enough stuff not to get myself in trouble has probably been tens of hours of otherwise billable time, plus the ever present risk of doing something wrong.
The problem is that it can be hard to know what is actually difficult, and what is easy but just expensive because not many people know how to do it. It would be nice if somewhere there was a definitive guide to what is worth doing yourself for any given hourly rate.
E.g. if your time is worth £50/hr then doing your own company set up is worth it, but you should hand off pay roll taxes to a professional. If your time is worth £100 an hour, then you should do these three things to cut cost a little, then outsource the rest.
There is an incredibly simple tax calculator at (http://www.corp.delaware.gov/frtaxcalc.shtml) that makes it obvious that there are two alternative methods of calculation with vastly different outcomes in terms of tax liability.
If you're going to bypass using a lawyer or tax advisor, you need to do your homework. Franchise tax for a C Corp with, say, 10MM shares at no par value and no assets should be about $150.
In general, many/most "startups" don't need to incorporate until one of a handful of triggers fire, such incoming investment, upside valuation event on the horizon, tax reasons, launch to the public, especially if the project/site/app is risky in terms of liability, some others.
Like many other real options (the option to incorporate or not, then where, in this case), it's often better not to exercise them early (except for the special reasons that mean otherwise).
As for legal issues - contracts are handled internationally all the time with ease. But liability issues vary dramatically from state to state and even more from country to country.
For a start up, unless the nature of the business is very liability intense, I would focus on the tax issues. As this article has shown, tax can be really, really expensive.
For starters, all companies need to be registered at the Court of Commerce, and each new company needs to have a name approved by a judge. Second, you're legally bound to have a name either in Croatian, Latin or Ancient Greek (or presumably another "dead" language, if you can prove it); and even if you do, a judge has to OK it (a friend of mine has recently been through about 30 names and still hasn't been approved; the whole process of approving a name can take days).
Then you have to physically go (yourself, or your lawyer) to 3 or 4 offices to file various registration papers; all in all it can take a better part of the month to incorporate. And to top it all, even if your company does nothing, has no income or expenses, it has some monthly dues to the state from day one, simply because it exists.
You can get a business registration, bank account and merchant account with gateway in Montenegro for a few hundred dollars and in a couple of days.
Heck, with a few thousand dollars you can register your own bank in Montenegro.
Not to be rude, but I'm unsure exactly where your story fits into that.
From 8 Delaware Code §503: "All corporations accepting the provisions of the Constitution of this State and coming under Chapter 1 of this title, and all corporations which have heretofore filed or may hereafter file a certificate of incorporation under said chapter, shall pay ...". http://delcode.delaware.gov/title8/c005/index.shtml
It is 8 Delaware Code §277 (http://delcode.delaware.gov/title8/c001/sc10/index.shtml) which says that Franchise taxes have to be paid by the corporation before the Corporation can be dissolved.
It sounds like the corporation is behind on franchise tax, and so is therefore insolvent - it has liabilities exceeding the assets.
If the corporation simply doesn't pay the franchise taxes for a year, the charter will be repealed (see 8 Del C. § 511, http://delcode.delaware.gov/title8/c005/index.shtml). Expect to lose all assets owned by the corporation, including any code.
IANAL, but I suggest you get advice from a lawyer or accountant about this.
How does this process work?
PS I say this as someone who did a DIY incorporation and had to un-do it at a later date when it didn't make sense...
Never accept the word of a lawyer on anything.
When it came to dissolving the company, the lawyer quoted us $3000 to dissolve. Not trusting anyone by that point, I called the companies house and they said that, to dissolve the company, all we had to do is fill out a form at their offices, we did it and we didn't even have to pay a cent.
Many lawyers will give you advice that leads to them getting paid more rather than benefitting you.
It sounds like you failed to communicate effectively with your lawyer to get the advice you needed. And that's what it is: advice. You can choose to accept or reject the advice since you are the one who is taking the actions.
By that logic, in the end it all comes down on the GP's "never accept the word of a lawyer on anything".
Many times, I've found that lawyers' and accountants' opinions on critical issues are diametrically opposed. Clearly, someone was wrong in those instances. As expensive as it is, I'm now leaning towards the idea that one should always get two independent opinions, just as a sanity check.
I also strongly recommend double-checking everything yourself. You're still getting professional advice, of course. But sometimes it's good to practice what's derisively called "playing lawyer" and do some legal reading.
A good lawyer or accountant will not mind you asking questions like: "The corporation code says X; could this be applied to me to mean Y?" If your professional does get offended by those questions, I'd consider it a red flag. You're paying by the hour, right? It's no skin off their nose if you want to chat.
I'm far from a defender of the UK in most cases - especially tax rates - but as a business person in the UK, I at least don't feel like the government or regulations are out to trick me and that I need an expert or a lawyer by my side for every decision I make.
Like I said other states have very different laws but most people will tell you that with all the bad delaware is still not decent choice to incorporate.
* First, there's not much evidence that the person we're talking about really owes a dime to Delaware. He set up a C-Corp (!), which apparently owes some corporate tax, but that doesn't make him personally liable. So, despite choosing the most complicated conceivable way to incorporate in the US, he can probably still just walk away.
* Second, does the UK have an LLC or S-Corporation equivalent? That is to say: is there a structure you can use to get pass-through taxation (business proceeds taxed once, as income) instead of corporate taxation, and have a shareholder structure that allows you to grant equity to employees? Because that is exactly the structure most pre-VC and bootstrapped startups want.
* Third, the US doesn't have the UK's system of rules requiring qualified directors; for instance, a bankruptcy in the US can't prevent you from being a principal in a company.
* Fourth, isn't it more expensive to incorporate in the UK than it is in the US? It costs under $100 to get a liability shield to do business under in the US. What's the equivalent UK cost?
* Fifth, and finally, aren't the laws in the US simply more business-friendly than in the UK? UK employees need to be given reasonable notice or compensation prior to termination; the UK is also not an "at-will" employment regime, making it harder to fire and thus harder to hire employees.
The UK is, from what I've read, the best of the business regulatory regimes in Europe, and the rules don't look onerous; they only look marginally more annoying than those of Delaware. However, I think that by looking at the weird choice made by one blogger (a full-on C-Corp), you might have gotten a distorted idea of what the regs in the US actually are.
Second, does the UK have an LLC or S-Corporation equivalent? That is to say: is there a structure you can use to get pass-through taxation (business proceeds taxed once, as income) instead of corporate taxation, and have a shareholder structure that allows you to grant equity to employees? Because that is exactly the structure most pre-VC and bootstrapped startups want.
A LLP - http://en.wikipedia.org/wiki/Limited_liability_partnership - provides pass-through and though it's called a "partnership" is actually a true corporate body. They are not very common as they were only created a few years ago and are not like US LLPs.
The standard "private limited company" represents nearly all of the corporations I encounter. These attract double taxation but this is not particularly onerous. Bear in mind that there are no "state" income taxes in the UK. There's one system, one set of rules, so on a £150k profit, the company would pay 20% corporation tax, and then the remainder split however many ways would attract personal dividend tax from each person. Thanks to a tax credit you get (to help counteract the corporation tax) the basic rate of dividend tax is effectively 0% (then you pay higher bands based on the dividend added to your normal income).
It's not exactly 1 + 1 = 2 territory, but it's a single system that any business owner or small-time bookkeeper can look up and feel confident about doing the calculations for.
Third, the US doesn't have the UK's system of rules requiring qualified directors; for instance, a bankruptcy in the US can't prevent you from being a principal in a company.
Yes, but this is an issue of personal bankruptcy which only lasts for 12 months (and potentially less). It's now common to take out an IVA (Individual Voluntary Arrangement) to avoid bankruptcy. Flipping it around, the UK doesn't have the US's system of "accredited investors" meaning that investment opportunities are open to more people ;-)
Fourth, isn't it more expensive to incorporate in the UK than it is in the US? It costs under $100 to get a liability shield to do business under in the US. What's the equivalent UK cost?
£20 ($32) - http://www.companieshouse.gov.uk/infoAndGuide/companyRegistr...
Fifth, and finally, aren't the laws in the US simply more business-friendly than in the UK? UK employees need to be given reasonable notice or compensation prior to termination; the UK is also not an "at-will" employment regime, making it harder to fire and thus harder to hire employees.
Yeah, there is some of this. However, a British company doesn't have any pressure to sort out health benefits and the legal costs are a lot lower (and the risk of getting sued for this and that seems to be somewhat lower based on the US and UK companies I know). So it's swings and roundabouts, as we say.
While "at will" employment is not (legally) done in the UK, it's not a particularly onerous system for businesses as long as they are careful. The notice period for an employee who's been with you for under 2 years is only a week, for example. For someone under a month, there's no notice period. As long as you aren't sloppy or outright discriminatory, you shouldn't be getting hauled in front of an employment tribunal.
you might have gotten a distorted idea of what the regs in the US actually are.
I did say it was subjective ;-) But I think a lot of it comes from the way in which the US has a plethora of particularly local laws. England, on the other hand, is more equivalent to a state and the laws across England are generally one and the same. Scotland has its own legal system but no-one in England would think to incorporate there (or in France, Germany, or wherever) in the way Americans incorporate across states.
Perhaps if people stuck to their own local states and were aware of their local laws, the situation would not be any more complex than in the UK. The interconnectivity of the US, however, means people do a lot of things across borders and seem to need expert help for everything.
Talk about an expensive mistake.
I have still not found what they define as "Beginning Business" in their legal statutes, but I'm assuming a company that never released a product and made no money would fit that definition. Of course, IANAL.
The various dissolution forms are here:
"Before the Certificate can be filed, all applicable Annual Franchise Tax Reports must be filed. Please contact the Franchise Tax Section prior to submitting the document for filing to determine the Annual Reports due. Please make your check payable to “Delaware Secretary of State”"
You just can't file the reports online, you'll need to talk to a representative of the Franchise Tax Board and they'll email or fax you the company's Annual Franchise Tax Report.
There is a lot of talk online about Delaware being the best state for incorporation. This is true if you are seeking outside financing, and most angels/VC's want to see a Delaware C Corp prior to investing. However, if you are going to raise investment, you need to have a lawyer anyway. So at the point you take investment, your lawyer can handle doing an incorporation in Delaware. No one should be filing for C-corporation status by themselves, with no background in the legal requirements.
In the meantime, if you are a startup who wants to put out a product for public use, or need to bring aboard paying customers of any kind, you should probably have an LLC. These are relatively cheap to create (and dissolve) and you can generally find law firms who will do pro bono work for startups in filing the appropriate paperwork (I have found several). Even LLCs require operating agreements and other paperwork before they are considered true legal entities. Any decent law firm does this all the time, and has the appropriate documents on file. Doing this yourself is again asking for trouble. For example, if you do business on behalf of your LLC as the "CEO", "President", or "General Manager", and have not specified that title in an operating agreement, you may be at risk of having the veil pierced (http://en.wikipedia.org/wiki/Piercing_the_corporate_veil), because you are transacting business on behalf of the company in a role that does not legally exist.
In most states, if you have an owner run LLC, your official title is "Member". However, most people don't want to represent their company as "Member", as this sounds weird, and is not a commonly used term. So in practice, you call yourself something else, like General Manager. If your operating agreement says that you can run the company under the title of "General Manager", or anything else you want to call yourself, then you are totally cool. If not, then you will be in trouble if a customer ever takes you to court.
To quote from Nolo.com (http://www.nolo.com/legal-encyclopedia/llc-operating-agreeme...) :
"The main reason to make an operating agreement is to help ensure that courts will respect your limited personal liability. This is particularly key in a one-person LLC where, without the formality of an agreement, the LLC will look a lot like a sole proprietorship. Having a formal written operating agreement will lend credibility to your LLC's separate existence."
The operating agreement usually specifies that the member can operate all aspects of the business, including hiring, firing, etc. So authority flows from the member in terms of other people's titles, and it is not necessary to specify lower level employee's title in the operating agreement. It is, however, necessary to specify the relationship of each owner in an LLC to the business if they will be transacting business on behalf of the company. This ensures that the veil between personal and company property remains intact.
However, I can tell you that the general consensus is that LLCs borrow from corporate law where piercing the veil is concerned.
Veil-piercing isn't about "transacting business on behalf of the company in a role that doesn't legally exist." That's an indemnity issue (the LLC is trying to shuffle blame from itself to an employee).
Veil-piercing is about going after the owners of a company on the grounds that the company is really just an extension of the owners' will and bank accounts.
Key factors for veil-piercing (for an LLC):
- Owners use the LLC funds for personal expenses without reimbursing the LLC.
- Zero/below-market loans from the LLC to the owners.
- LLC business decisions made to benefit the owners rather than the business.
- Undercapitalization (LLC not have enough money to pay its bills/expenses/liabilities without the owners covering some of these expenses).
There are more, but those are the big ones. The piggy-bank, low-interest-loan, and undercapitalization factors are usually the most important.
No... you are confusing the issue.
By way of example, let's say that I am running a member (owner) managed LLC. My official title under state law is "Member". But I sign all my documents with customers and suppliers as "CEO". Then, the company goes broke, and owes money to its suppliers. The suppliers could argue that I did not represent the company in good faith, because I was not the CEO of the company. That position doesn't exist. So they might want to come after me personally instead. Depending on the laws of your state, the court may agree that you did not represent the company in good faith, and allow your suppliers to pierce the veil and come after your personal assets.
The only way to shift blame to an employee would be in cases of fraud or gross negligence, and even then, your company would probably still be liable. What I am discussing is only really relevant in cases where the owner and manager are one and the same (as in the case of the original poster's situation). This doesn't apply to employees who may sign on behalf of the company for routine transactions, but don't have any controlling interest in the company. However, as a manager, it is best to make sure that anyone with signatory authority in your company is given such authority in the operating agreement. However, there is no such thing as piercing the veil with regards to an employee of a company who does not have a substantial ownership stake. They will always come after the owners of the company if it seems that the company is a sham to protect personal assets. The more loosely you operate your company without specific legal agreements (ie operating agreement), the more likely someone will be able to prove that the company is a sham.
That's what I thought, because it doesn't make sense. But I wanted to give him a chance to defend his statement.
Read the post.
But actually, don't listen to me, I'm the one whose in this ridiculous mess.
A C-corporation in Delaware is considered the best entity for raising outside investment. The State of Delaware knows this, and charges hefty fees for maintaining a C-Corporation, and apparently for dissolving one. So it makes very little sense to incorporate in Delaware unless you will be raising an outside round of capital, because the costs of maintaining the C-Corporation itself are very high for a start-up with no money. Recognize that a "do-it-yourself attitude" is awesome for developing start-ups. It is perhaps one of the worst attitudes to take in terms of corporate entity formation and maintenance. Documents on file with a law firm with appropriate date and timestamps are virtually bulletproof in court. This is one of the many reasons law firms exist. Documents pulled out of your filing cabinet, to which only you have been privy until the time they end up in court, are a bad, bad idea. Bootstrapping your legal documents or anything else having to do with your corporate entity is a flat out terrible idea, unless you basically do this for a living (in some cases, there are startups who create LLC's daily, in which case you presumably know all of this already).
I did it mainly to limit liability, among other reasons. However a little while after forming, I spoke to a lawyer and he said that it basically doesn't limit you from being sued personally. You "can" attempt to deflect personal lawsuits with the LCC (easiest if you keep its finances/files/bank-account separated from your personal stuff, which I did), but it's no guarantee.
He basically advised me that forming the LLC was a waist of money in my situation, and I would have been better off simply as a sole-proprietor (e.g. DBA - doing-business-as). From the IRS's perspective, I was treated as a sole-proprietor for tax purposes (they don't recognize LLC's for single individuals). Of course by then, it was too late to easily dissolve the LLC and "switch" it to a DBA, so it was money wasted.
What annoyed me the most is the same problem Hamza had in the article. You have to pay money to dissolve a business! Really? REALLY?!? Obviously the business failed, or is being abandoned, because it didn't make enough money. Charging a "death tax" on a business seems pretty harsh. I understand if there's a filing fee of $20 or $30, but anything higher than that is ridiculous. Delaware wanting $1,600 from Hamza is downright insane. Perhaps there's more work involved dissolving a C-Corp than an LLC, but still, $1,600 is ridiculous.
Charging a business death-tax reduces seed capital needed to form a new business. Second, it reflects badly on the state, reducing the likelihood of incorporating in it again. Lastly, why not ignore paying the fee altogether, declare bankruptcy, and waste the time/money of the court system dealing with it all? I'm not sure about the legal implementations of that, but it might be a valid option if the C-Corp has no assets left. AFAIK you cannot ask shareholders to pay for it since they're legally shielded from the debts of a C-Corp.
On the other hand, it is very difficult to pierce the veil of a business entity with more than one owner (unless the second owner is a spouse or family member of the first).
In the meantime, how about IRS code that allows an inventor who owns his invention personally to take capital gains treatment on the sale of that invention contrasted with ownership by an LLC (even single person LLC) or other entity which subjects the owner at sale to normal income taxes at (usually) a much greater rate? I can imagine many convincing reasons for the entity to own the code. But why do that unless you have to? I would tend to want to own the code personally. More flexibility.
The whole point of a corporation is that you aren't personally liable for its debts! You just paid $400 for no reason!
It was eventually struck off the registry and I never heard anything again, and have even registered other corps since.
The only time you wouldn't is if you have taken an investment and want to provide a tax writeoff to investors, or if there are assets to divide. Then it needs to be disolved properly.
(Edit: to add here, if you have been negligent or criminal the creditors will usually be granted a court order to chase up debt with the directors personally. This is rare. In this case you have franchise fees that were run up in the course of doing business. The one thing to learn here that should have been in the original article is that Delaware's main source of revenue is franchise tax, which is calculated on the number of shares issues, so keep that number very low (ie. 3 founders = 3 shares). That is a pretty big thing to miss, IMO.)
Benefits: no corporate taxes, no accountant to pay. Vesting is automatic (4 years, monthly, just like founder stocks in a Silicon Valley startup). And it's legally binding (thank you copyright law, for once you were useful).
You could find yourself on the hook for thousands of back taxes plus fines if your "virtual corporation" is successful. And that doesn't even include potential state tax liabilities or self-employment taxes.
Is incorporation premature optimization?
I just (re) incorporated in Oregon. I think it cost $150 (was $50 until 2009), and took about two days. IMO it's well worth it for legal protection from losing personal assets.
The minimum corporate tax in OR is $150. In 2009, they raised it from $50, and (I think) increased the tax rates across the board. The biggest change is that they now tax on gross receipts which means you can't deduct expenses.
You can let the company fall into bad standing.
I have heard of the various risks with doing that, and I've never understood how those risks go away with dissolution.
If the company is shutdown and not making money, then failure to file annual reports and tax returns is irrelevant because you will have no income to be taxed or fined against. You would have annual state filing fees that would go unpaid, but you would never be personally liable for them. And I can't imagine how you would be personally liable for the actions or inactions of a corporation that conducted no business.
In the UK at least I believe you can be prevented from holding directorships in other companies, which may mess things up for you personally in the future even without a financial impact.
Not sure what happens if all the directors in a company resign?!
If you're not serious enough about your new business to pay for professional advice - you're not serious enough to start it.
I created the corp as an experiment and will see how it goes.
Finally, I've posted this link to our site before: http://www.mynewcompany.com/annual-report.htm
Bookmark it, and then you can check a) when and if you have an annual fee due for your company/state and b) what the filing fee is.
I'm more of a creative mind/sales guy. I'm an okay web designer, with very minimal programming skills. I tried to develop a tech driven start up and handle everything on my own including the programming. I worked so long & hard trying to take care of things I wasn't skilled enough to do that I was too exhausted to maximize on my talents.
So, I would say focusing on your strengths is a key to success. Marcus Buckingham has nice insights on strengths. Check him out.
Bringing it back to a computer metaphor would be :
Of course you should have done backup, everybody knows that ! You now need to pay 89000$ whether or not you need your data on that drive. You should have consulted an enginineer before buying a computer of course !
See... small mistake, disproportionous response.
At least think that you did nothing wrong, it's just that the law is unfair.
you might get some nasty letters. yawn.
As others have said, DE has a great, business-optimized court system. But if you don't live in DE, you're instantly at a huge legal disadvantage if anything comes up. Meanwhile, you'll be stuck paying:
* annual corporate filing fees (WY), minimum franchise taxes (DE), licensing fees (NV), income taxes (many states), etc. in the state in which you've incorporated.
* foreign corporation fees/taxes and income taxes in your state of residence.
* foreign corporation fees/taxes and income taxes in any other state where you do conduct significant business beyond sales.
* registered agent fees in the state in which you've incorporated.
* possibly mail forwarding fees, depending on what you're trying to do.
(I incorporated in Wyoming last year, then realized how dumb that was, dissolved the corporation, and re-incorporated in my home state this year)