Corporations are not particularly hard or expensive to start, maintain, or dissolve - but you need to be at a stage of life where a thousand dollars here or there is not a major burden. If you are not yet at that stage, that is a different story and there is no doubt that forming or dissolving an entity such as this will normally set you back a thousand or two on either side. In that case, you should tread cautiously unless you can raise some funds (even if it friends-and-family money) to be able to handle such costs without too much pain.
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.
One caveat for those conducting business from California is that you have to pay the CA $800 franchise tax even if you incorporate in another state. This seems to be something people don't catch after filing it do-it-yourself Delaware co's/LLCs online. If you're running your startup from California, incorporating in Delaware technically exposes you to costs from both states.
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.
That's correct. California requires "foreign" corporations (any business entity incorporated in another jurisdiction) "doing business" in Califoria to register as a foreign corporation (or LLC) in California. This "franchise tax" is similar to the "franchise tax" paid by domestic corporations (incorporated in California), and is the greater of net income from California activities (all activities, for California-based companies) or $800.
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).
Another good example of a big, high revenue/high profit corporation that isn't a Delaware corporation is Microsoft. They are incorporated in Washington.
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 believe Microsoft was a Delaware corporation for many years -- at least for several years that I worked there in the '90s. I don't know why they changed.
I suppose in the end it comes down to how much stuff you can (or want) to hold in your head at the same time.
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.
I'm at a loss to understand the headline of the original article.
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.
Excellent write up, George. Even before the "where" to incorporate question, people need to answer the "if," "when," and "why" questions (and some others).
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).
I wholeheartedly agree. Really good point! Wait to swing at that ball until it has almost hit the floor--wait, hold, wait, hold, and wait some more. And other than the fact that the article addresses incorporating in Delaware, why are we limiting this discussion to corporations as apposed to the myriad of other entity solutions? And shouldn't we be discussing how to formalize our relationships so that the formalities HELP us, not hinder us? So I would add "what kind of formalities do we need" and then "what kind of entity?" to your "other" questions as well. I don't know if you need a lawyer -- depends on the lawyer -- a lawyer who is willing and able to see into the dynamics of the group and has the wisdom to keep the agreements as loose as possible for as long as possible.
For non-US citizens/residents who are building startups focused on the US market, do you have any suggestions on where to incorporate (e.g. in the US, offshore, "home" country etc)? How much of the decision should be based on potential legal issues and how much on tax?
From a tax perspective, locating the US office in a tax free jurisdiction is most wise. These states would include Washington, Nevada, Wyoming, Texas, Florida, and (sort of) New Hampshire. Also, setting up a relationship between the foreign entity and the US entity to minimize US taxes (as Microsoft has done --see above) certainly helps. Finally some attention has to be paid to the tax effects on the US citizens (or green card holders) and the non citizens (or green card holders). Most foreign tax questions involve an expert in the US as well as in the foreign jurisdiction.
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.
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.