Where Should I Incorporate?
The Answer Is
Over the years, I have worked with lots of startups in the early stages. Two people and an idea. In startup incubators all over the United States startups grapple with seemingly simple questions. One of the first questions a mentor asks a startup business is “Are you a C-corp?” The reason it’s asked is twofold:
No respectable institutional investor will put money into anything but a C-Corp. Corporate law and the protections surrounding investors are transparent. Institutional investors would have trouble with their Limited Partners if they invested money into anything other than a C-Corp.
QSBS. There is a provision in the IRS tax code that says if you invest in a company with a net worth of less than $50MM and you hold the investment for five years or more, you pay 0% state and federal tax on the gains if it is a C-Corp. There is no tax benefit to institutional investors if the investment is an LLC.
When the startup asks, “Where should I incorporate?”, there always has been only one answer. Delaware. Delaware had settled law, judges that practiced and ruled objectively, and a bunch of law firms that had years of experience and a lot of internal expertise passed down from generation to generation that made Delaware appealing.
That’s not true anymore.
Asked the same question today, I might say, “Nevada”.
Nevada has a lot going for it. It’s building a great corporate law bench. Artificial intelligence allows expertise and internal knowledge to be passed down faster. The judges seem to be more objective.
The Tesla case has put a big spotlight on the objectivity of the Delaware courts. Once a court becomes politicized, you can’t change it and its credibility is forever besmirched. The judge in the Tesla case ruined years of hard-earned credibility.
Musk has incorporated his business, Neuralink, in Nevada. He has said he is moving other businesses out of Delaware and California to Nevada or Texas. Other startup businesses are looking to move and some established businesses are looking to move.
For sure, we are in the very early stages of this three-act play. I don’t expect the Fortune 500 to recharter their companies anytime soon, but I do expect startups across the country to abandon Delaware for other states.
Nevada is a mostly blue state politically. The Democrats have gerrymandered and mail-in balloted their way to power. In the last couple of years, the Republican Lt. Governor, Stavros Anthony, has worked hard to bring artificial intelligence companies to Nevada. The state’s Republican governor, Joe Lombardo, has worked on big business. Companies are moving to Nevada out of California, just like people. I suspect the same phenomenon will happen with companies in Washington and Oregon. Washington legislators have seen fit to institute an adverse capital gains tax that hurts startups.
Nevada doesn’t have much of a startup scene yet. It needs some things like a lot of very early-stage risk-loving venture capital. It lacks a major research university, and there is no real intense science-based research park. It had no entertainment scene either but it’s now the entertainment capital of the world. Mark Wahlberg is building a studio in Las Vegas after abandoning Los Angeles.
It does have great weather, great taxes, and a culture that allows anyone to make it. The culture in Nevada is merit-based and a lot of that stems from the entertainment industry. It’s not “who do you know”, it is “what can you do”. That subtle little difference is huge when it comes to building a startup community.
Las Vegas has some tailwinds when it comes to startups. Nevada has a stable and good infrastructure. It’s not threatened by natural disasters. The police department is respected and supported, even by Democrats. Las Vegas is one of the best airports in the world. It’s becoming a larger node in shipping hubs because of all the warehouses being built. Because of the convention industry, people come here from all over the world all the time so your customers come to you.
If I were a startup today I would look at Nevada as the place to incorporate over Delaware.
68% of the Fortune 500 and 93% of all IPOs in the last 5 years are chartered in Delaware. There must be a good reason.
Delaware has been at the racket since the early 1900s and has a court -- the Chancery Court -- and a body of law -- Delaware Corporation Law -- that addresses and has for more than a hundred years the unique interests of both companies and shareholders.
Delaware's administrative processes allow for one day entity formation, anonymity (only the registered agent of a corporation must be revealed), no franchise tax, no state income tax, and expedited hearings.
One must understand the Chancery Court -- no jury trials meaning no outlandish awards and, rarely, punitive damages, judges who specialize solely in corporate law, a huge body of written and common law, and predictable outcomes -- is very good both companies and investors.
Nevada first contemplated a chancery court in 2009 and its corporation law is a cut and paste job of Delaware. There is no substantive difference; but what is different is the paucity of legal precedent.
Delaware Chancery Court has been spitting out case law for over a century, whilst Nevada has been in the racket for less than 14 years.
Delaware Chancellors are experienced and the legal profession in Delaware is salty and seasoned; not so much in Nevada.
I really cannot find a meaningful difference between Delaware and Nevada other than experience both on the bench and amongst the lawyers.
The law upon which Elon Musk caught his toe is identical in both jurisdictions, so other than a bruised ego, not sure what he thinks the benefit might be.
As to Musk's particular situation, beyond the initial shock, in depth analysis indicates he DESERVED to have his employment agreement voided.
He muscled through the agreement, he wrote the agreement, no evidence of adversarial negotiation, his board included persons who reported to him, were blood relatives (his brother was on the board for goodness sake), and persons who had made once in a lifetime fortunes because of the option grants he provided to them as board comp.
Musk socialized with members of the board and used drugs with some.
Does that sound like the US Securities and Exchange Commission independent board required by virtue of being public?
These facts would be the same in both Delaware and Nevada.
The Chancellor who wrote the opinion -- after the initial shock of Peck's Bad Boy not getting his way -- detailed this in a thoughtful, well-documented opinion that detailed every transgression.
I admit I started out reading it wanting to be critical, but by the time I finished, I said, "WTF, Elon? It's a bloody public company and you only own 13%. Follow the God damn rules."
Musk is not getting nothing -- the board has to go remake itself and negotiate a new agreement that does not violate the basic tenets of corporate governance. You can't put your brother on your board and argue it's independent.
So, leave Delaware? For Nevada? If based on Musk's issues, not the smart move.
JLM
www.themusingsofthebigredcar.com