Every business, small or large, needs to make a decision regarding its state of incorporation. For small businesses, it is fairly simple. The question gets much more complicated as the business grows or the company wishes to go public. For many years, Delaware was the haven for publicly traded companies. They were winning the Race to the Bottom. That is, they retained less and less control of the affairs of the corporation, while providing directors maximum flexibility in their dealings with the shareholders. As the individual states change their laws, Delaware is becoming less and less popular as a state of incorporation.

SMALL, CLOSELY HELD CORPORATIONS

Many entrepreneurs have heard about Delaware (or Nevada) corporations and decide to be incorporated there, without full knowledge of the legal and tax ramifications. The three most common reasons entrepreneurs site are the lower filing fees, tax advantages, and anonymity for corporate directors. Delaware does not require that the officers or directors appear in the Articles of Incorporation. The state may never find out who the principles are. Also, there is no corporate income tax in Delaware for companies that do not transact business in Delaware.

However, the state of Illinois and all other U.S. states have adopted a statute to deal with these foreign corporations. In Illinois, Article 13 of the Business Corporation Act of 1983 is the controlling statute. It states, "A foreign corporation organized for profit, before it transacts business in this state, shall procure a Certificate of Authority to do so from the Secretary of State." Not coincidentally, the filing requirements to obtain the Certificate of Authority are very similar to the requirements for filing Articles of Incorporation. If an entrepreneur incorporates in Delaware, not only will the entrepreneur pay two states' annual filing fees and franchise taxes, but he will also have to pay registered agent fees in Delaware.

The state filing fees for the Certificate of Authority are the same as those for filing Articles of Incorporation in most states. In some states, such as Texas, the filing fees for a foreign corporation are higher. If a company is looking just to save on filing fees, it is clear that the best place to incorporate the new company is in the state where it is located. Otherwise, filing fees will be doubled.

In applying for a Certificate of Authority, the State of Illinois requires more disclosure than it does in the Articles of Incorporation. While the Articles of Incorporation only require the disclosure of necessary information such as the name and address of the registered agent and some basic information on the authorized shares, the application for the Certificate of Authority requires disclosure of officers, directors, principal business activity, and detailed financial information. Entrepreneurs looking to avoid these disclosures are actually better off incorporating in Illinois rather than Delaware.

Everybody is looking to minimize their tax liability. A Delaware corporation that does not transact business there does not pay tax to the state of Delaware; however, such a corproration does not not pay tax to Hawaii, California, New Jersey, or any of the other states in which it is not transacting business, regardless of where it is incorporated. Where a corporation pays tax and where it is incorporated are entirely separate issues. Taxes are paid based on where the income is derived, not where the company is incorporated. A Delaware corporation operating in Illinois pays the same tax to the state of Illinois that an Illinois corporation pays.

PUBLICLY TRADED AND OTHER COMPANIES

Although many publicly traded companies which historically have incorporated in Delaware, they understand the tax fallacies mentioned earlier in this article. The difference in filing fees from one state to another is insignificant to them and the disclosure requirements are irrelevant since most of the information can be obtained through other means by anyone who is interested anyhow.

Historically, Delaware's Division of Corporations was by far, the quickest and had the most efficient procedures for filing Articles of Incorporation. In the recent past, dealing with states other than Delaware was a nightmare because they did not keep up with the speed of business. Often times, corporations need to be set up for the purpose of a single transaction, series of transactions, or for a holding company. When time was of the essence and the state of incorporation was irrelevant, companies often incorporated in Delaware because Delaware corporations could be created quickly and efficiently.

Today, many of the other states have caught up and passed Delaware for their efficiency. The fastest Delaware can file your document is a few hours, and you can have the stamp filed documents on your desk the day after Delaware receives them. Compare this to Florida where the Florida division of corporations will actually fax the filed document and a certificate to you within a few hours. The filing is actually done electronically and the Articles of Incorporation are faxed to the state later. Since Florida has people working after business hours and early in the morning, corporations can be formed entirely outside of business hours. I have electronically filed a Florida corporation and faxed the Articles of Incorporation to the Florida Division of Corporations at 7:00 p.m. and I had a response on my desk when I walked into the office at 8:30 the next morning.

Franchise Tax Bills

All states require an annual report to be filed along with an annual fee or franchise tax bill. If the report is not filed, the corporate charter will be revoked or the company administratively dissolved. The franchise tax bill varies from state to state but is is usually approximately the same amount as the initial filing fee, approximately $100-$200. Some states, like Delaware, base the annual fee on the number of authorized shares, outstanding shares, actual assets, or a combination of those factors. In Delaware, a small public company ($60 million in assets) may have an annual fee of approximately $12,000, while a large company may have an annual fee of up to $150,000, which is the most any company will pay in Delaware. The same company, incorporated in Florida, will have an annual fee of $150. This difference results because Florida charges the same flat annual fee to all corporations, regardless of their size or number of shares.

Sunglass Hut, which has its headquarters in Florida, is one example of a company that realized the advantages of being domiciled in Florida, rather than Delaware, and changed its domicile to Florida from Delaware. The transfer is simply a series of filings. A new corporation must be formed in the new state (in this case, Florida). The Delaware corporation then must file Articles of Merger and a Plan of Merger in Delaware and in Florida. The Delaware corporation is the disappearing corporation and the new Florida corporation is called the surviving corporation. Consent of the shareholders is necessary before the merger takes place. This reincorporation procedure can save a company up to $150,000 annually. In the case of Sunglass Hut, the tax saving was about $30,000 in 1996.

Traditionally, larger companies chose Delaware to take advantage of laws surrounding the relationship between the directors and shareholders. Delaware has a special court system called the Court of Chancery to deal with the disputes that arise regarding disclosure and shareholders rights. Over time, this particular body of law has become developed and is very complete. The board of directors know exactly where to walk the fine line. While other states have tried to form their laws around Delaware law, only time will develop the case history surrounding the statutes. Unwilling to take this leap into the uncertain, the board of directors of large, publicly traded companies may resist a change of domicile. No other state can compete with Delaware in this regard. If potential litigation on this issue is a real factor, a company may want to spend the additional $100,000 or more annually on the security of the Delaware law.

Choosing the domicile of a publicly traded company is a fairly complex and difficult decision and all factors should be considered carefully. Many corporations alive today were incorporated many, many years ago in Delaware when the decision was easier. It may take some time for companies to follow the lead of Sunglass Hut, but eventually the classic Delaware corporation will be on the shelf with your 8 track player and your rotary phone.