The first slide is ironic. "Keep it simple" by forming a Delaware corporation is advice constantly repeated in some circles and it's simply asinine.
The simplest option for founders is to incorporate in the state in which they reside/plan to conduct business as they are going to have to file as a foreign entity in that state anyway.
The retort is "But investors won't invest in my California LLC!" The first fact this argument overlooks is the that most companies are never able to raise institutional capital. So incorporating in another state for investors you don't have is entity selection's form of premature optimization. Investors look to invest in promising businesses; they aren't seeking out investments in Delaware companies.
The second problem with this argument is that it pretends entity selection can't be easily revisited. It can. As I have pointed out before[1], converting to a Delaware corporation is generally a straightforward process. If you have a California LLC, for instance, and need to convert to a Delaware C corporation, it is unlikely to be anywhere near the most complicated or costly part of a financing.
Telling founders they don't need to understand legal and accounting nitty gritty and that they should just follow boilerplate advice ("form a Delaware C corp") is in my opinion bad advice. Understanding the details and why you're doing something won't guarantee that you build a great business, but it can save a great business from legal, tax and accounting mistakes that can be fatal.
Entity conversion isn't going to be the most complicated or costly part, but it could actually be the most time-consuming depending on the state you're converting from and a bunch of other factors. I've seen it take months - you can imagine the founders weren't happy (wasn't CA though).
I think you need to consider the target audience of the presentation - it's for people who want to start high-growth tech companies that will raise venture capital. If that's your goal, then the simplest option by far is to incorporate as a Delaware C-corporation. On the other hand, if a larger goal for you is to save a few hundred bucks a year on the extra franchise tax, then yea - maybe you want to incorporate in your home state. But then you're not the intended audience for this presentation or the advice contained in it.
I'd also just point out that telling people to just incorporate in their state of residence is no less boilerplate advice than telling people to incorporate in Delaware :)
> I think you need to consider the target audience of the presentation - it's for people who want to start high-growth tech companies that will raise venture capital.
Correction: it's for people who have been convinced (or are in the process of being convinced) that they're starting high-growth tech companies that will raise venture capital.
Just because you immerse yourself in Silicon Valley culture and create a "startup" does not mean you actually have a high-growth business, or that you're going to raise capital from institutional investors. The vast majority of "startups" never achieve high growth, and venture firms reject far more companies than they fund. If you have a great business worth funding, no institutional investor is going to walk because you may need to revisit entity selection.
> I'd also just point out that telling people to just incorporate in their state of residence is no less boilerplate advice than telling people to incorporate in Delaware :)
I didn't advise that founders incorporate in their state of residence. I stated that this is the simplest option. And it is. That doesn't mean there aren't situations in which the simplest option is not the best option, but if you're going to rule out the simplest option, you should understand why doing so makes sense.
1. No VC will not give you a term sheet - probably true (so long as you don't tell them about all the time / money you spent trying to optimize your legal structure for what they would consider to be the failure case). But there's this concept called "deal risk" - the longer it takes to get a deal done, the greater likelihood something will come up that blows it up.
2. Incorporating a Delaware C-corporation is by far the simplest option for high-growth tech startups. As an attorney in Silicon Valley, I cringed every time I had to deal with some other type of entity because it just wasted a lot of time (and thus the client's money) figuring out stuff that is muscle memory for Delaware C-corporations. And it always is painful to see the horror stories, like the one mentioned in the lecture. It's experiences like that that lead startup lawyers to advocate just going with the beaten path. All the extra headache is just not worth the few hundred dollars you save in franchise taxes. Penny wise, pound foolish.
> Incorporating a Delaware C-corporation is by far the simplest option for high-growth tech startups. As an attorney in Silicon Valley, I cringed every time I had to deal with some other type of entity because it just wasted a lot of time (and thus the client's money) figuring out stuff that is muscle memory for Delaware C-corporations.
No offense, but this says more about your experience than it does about California corporate law. When you have a hammer, everything is a nail. Just because you worked at a full-service law firm that primarily deals with companies incorporated in Delaware doesn't mean that your experience represents all attorneys.
Maintaining a California corporation is not rocket science. There are plenty of competent, experienced attorneys in California who have "muscle memory" when it comes to California law.
Let me put it to you this way - if you are building a high-growth tech company, you want lawyers who specialize in high-growth tech companies.
Since most high-growth tech companies, at least in the US, are Delaware C-corporations, the lawyers that specialize in those companies are going to be most familiar with Delaware C-corporations.
Do these lawyers have to be at large law firms? Nope, as you mentioned, there are plenty that are out on their own or are at smaller firms.
As I suggested above, the problem is that just about everybody in Silicon Valley is convinced they're starting a "high-growth" tech company, even when they have little more than an idea on a napkin.
The number of companies that actually achieve high growth and have high-growth company legal needs is small, as is the number of startups that raise institutional capital. Heck, lots of companies struggle and fail to raise any funding at all. Of those that raise seed funding from angels, the majority will not be able to secure a real Series A.
Structuring your entity and selecting an attorney on the assumption that you're starting a high-growth enterprise before you are anywhere close to having one is like spending all of your time and money trying to architect a web application that can support a billion users before you even have your first 100. It's premature optimization plain and simple.
On that point, I have never met an entrepreneur who failed because he or she didn't incorporate in Delaware or retain a "startup attorney" with a fancy office on Page Mill Road. I have met plenty of entrepreneurs who have failed in part because they took on certain expenses prematurely based on misguided assumptions and rosy projections.
Everything you're saying would make a lot of sense... except that incorporating as a Delaware C-corporation basically takes the same amount of time and money, if not less. It's not that complicated.
You don't have to get an attorney with a fancy office on Page Mill Road. But even if you did some big law firm, you would probably get a fee deferral that covers formation, so you're not out of pocket anything anyways.
Totally unrelated but wanted to say that I love your comments on HN. Always insightful and straight to the point.
Know your anonymous on HN but would love to hear your thoughts on emerging startup tech company funding models and which, if any, you like? Revenue-based financing as one example.
Ping me at asanwal(at)cbinsights(dot)com if interested and we can set up time to chat.
Thanks again for all the great contrarian (for HN) comments.
Sure, if you're planning to run a lifestyle business do whatever you want.
But if you're not, consider when you have an interested potential investor who's mulling over your business model and asks offhandedly, "So you're a Delaware C-Corp, right?" and you answer with this.
Then he thinks: "if they didn't even get this right, what else have they missed?"
As someone who has pitched many investors, sometimes successfully, I can tell you that nobody ever asked about the incorporation status of my company until well after the deal was agreed to. Investors care about you, your team, your traction, and your product. Everything else (including some terrible incorporation and accounting mishaps) can and will be fixed if your company is good.
I would be more suspicious of a founder that spends too much time getting their incorporation just right - for businesses that are going to raise institutional capital, that's really the least of your concerns.
The decision about where to incorporate shouldn't just be about taxes - you're signing up for a body of corporate law and procedure and the differences can have a big impact. And CA vs DE is just night and day in terms of user-friendliness. Sure you could save a few hundred dollars in taxes by incorporating in CA, but you'll burn through those savings on the first day your corporate lawyer has to address one of the many strange/frustrating things about the California Corporations Code. Or when you need to pay a rush filing fee to amend your charter in CA because otherwise they'll sit on it for a couple weeks.
If you're running a lifestyle business that never has any corporate legal activity then maybe it won't matter, but I think most folks would be better off minimizing legal fees (measured in hundreds per hour) instead of taxes (measured in hundreds per year).
> The decision about where to incorporate shouldn't just be about taxes - you're signing up for a body of corporate law and procedure and the differences can have a big impact. And CA vs DE is just night and day in terms of user-friendliness.
I never suggested the entity selection issue boiled down to taxes and taxes alone.
You seem to be under the impression that matters of corporate law are a lot simpler than they actually are. This article[1] explains why that's not always the case. Bottom line: incorporating a California-based business in Delaware doesn't necessarily allow you to avoid the California Corporations Code.
If you operate a startup based in California, the majority of which is owned by California residents, you are absolutely not going to see your legal costs reduced by incorporating your California-based business in Delaware.
In practice, Section 2115 doesn't change much of how a DE company in CA operates. Every experienced startup lawyer routinely represents DE companies in CA and knows the few places where you need to think about Section 2115, so this has basically zero effect on fees.
Representing a DE company based in CA is the default for corporate lawyers in SV - being incorporated in CA is a complication that forces your lawyer and opposite counsel outside the normal groove.
I'm sorry, but you are just plain wrong about legal costs. Ask any reputable startup attorney in Silicon Valley whether it is net-efficient to start off as a Delaware C-corporation or a California entity.
> Ask any reputable startup attorney in Silicon Valley...
By "reputable startup attorney in Silicon Valley" I assume you mean a partner at any of the brand name full-service law firms that bill associates out at $400-500/hour for cookie-cutter work (like Delaware incorporation). My SO is a Biglaw attorney so I know how the game works.
You can easily find highly-experienced solo attorneys, many of whom have Biglaw backgrounds, or small firms run by experienced attorneys, who offer their services at hourly rates below the rate an inexperienced second year associate at a Palo Alto Biglaw firm is billed out at.
So I'll suggest a different question: ask any honest attorney whether it's net-efficient to retain a Biglaw firm before an individual has a real business.
Yes, the incorporation is just the beginning of the cookie-cutter work that gets performed by associates who are billed out at exorbitant rates not justified by their level of experience.
I don't have anything against Biglaw. There is a place for the large full-service firms. But I can retain one at any time. At the earliest stages of a company, incorporating in Delaware "because VC" and retaining a Biglaw firm "because success" is just foolish for the average entrepreneur, especially young first-timers who have a high likelihood of failure. Entity selection is usually easily revisited, and you can get high-quality legal counsel at a fraction of the Biglaw cost.
Google started out as a California corporation, and remained one through its A round. It only became a Delaware corporation when it started to lay the groundwork for the IPO.
Unless the company is only in Delaware, forming a Delaware corporation causes it to have at least two different sets of tax laws to contend with. As startups are typically not in a very strong financial position, chances are that for most start ups such a choice is introducing pointless and worse potentially very costly complications. For example, a company that registers as a Delaware corporation but spends any time in Calofrnia conducting or operating its business (e.g. for YCombinator) almost certainly has to register as a foreign corporation in California and pay the minimum franchise tax. They'd have to pay the same as a corporation registered within CA (not as a foreign entity). So the Delaware incorporation is just an added legal and financial complexity with what is very likely little or no benefit (i.e. asinine).
The simplest option for founders is to incorporate in the state in which they reside/plan to conduct business as they are going to have to file as a foreign entity in that state anyway.
The retort is "But investors won't invest in my California LLC!" The first fact this argument overlooks is the that most companies are never able to raise institutional capital. So incorporating in another state for investors you don't have is entity selection's form of premature optimization. Investors look to invest in promising businesses; they aren't seeking out investments in Delaware companies.
The second problem with this argument is that it pretends entity selection can't be easily revisited. It can. As I have pointed out before[1], converting to a Delaware corporation is generally a straightforward process. If you have a California LLC, for instance, and need to convert to a Delaware C corporation, it is unlikely to be anywhere near the most complicated or costly part of a financing.
Telling founders they don't need to understand legal and accounting nitty gritty and that they should just follow boilerplate advice ("form a Delaware C corp") is in my opinion bad advice. Understanding the details and why you're doing something won't guarantee that you build a great business, but it can save a great business from legal, tax and accounting mistakes that can be fatal.
[1] https://news.ycombinator.com/item?id=8393109