Whether for real or merely perceived reasons, business clients often propose incorporating in Delaware instead of Minnesota. While a Delaware incorporation may be advantageous to some businesses, those benefits often are not so certain or clear as to outweigh the benefits of incorporating in Minnesota.
Perceptions of Corporate Formation in Delaware and Other States
It is not unusual for Minnesota business attorneys to receive a client request to incorporate a new business in Delaware, Nevada or Texas. The typical explanation for the request is some variation of “no state income taxes,” “better liability protection,” “less expensive to administer,” or “I read an article on the Internet recommending it.” None of these reasons, without more, typically justify incorporation by a Minnesota-based client in a state other than Minnesota.
Some Advantages of Incorporating in Delaware
In limited situations, a business will be better served by incorporating in Delaware. A primary basis to do so is a business plan to eventually convert a privately-held company to a public company. As Delaware is home to a high concentration of Fortune 1000 companies, it has a well-developed business law case history. Moreover, its business code, the Delaware General Corporation Law, is regarded as business-friendly and cutting edge.
Minnesota’s Business Corporation Act contains a section that provides a modicum of protection for minority shareholders in entities of a certain size. Minnesota statute section 302A.751 provides for judicial intervention in the case of unfairly prejudicial conduct by other shareholders or directors. There is no such equivalent under the Delaware General Corporation Law. Accordingly, for a shareholder or group of shareholders with majority control, not being subject to a statutory standard of conduct towards minority shareholders would be an advantage, as it lessens the risk of future minority shareholder claims.
A right to cumulative voting, which provides some protection to minority shareholders in certain voting situations, is not a default provision under the Delaware General Corporation law, unlike Minnesota. Likewise, preemptive share purchase rights are a default provision in Minnesota, but not Delaware. These provisions may provide some benefits to minority shareholders, especially in the case where standard Minnesota articles of incorporation are filed to create the entity. The absence of these provisions under Delaware law provides an advantage to majority shareholders. (This advantage is not significant at the business formation stage, however, because even in Minnesota the incorporator can “opt out” of cumulative voting and preemptive rights in the articles of incorporation.)
Delaware, unlike Minnesota, does not have a state corporate income tax. For a multi-shareholder entity in which shareholders live in different states, there may be a simplicity and cost-savings to not having to file an individual return in Delaware. This benefit may be limited, however, if the revenue producing activity takes place in another state, a typical situation for Minnesota-based clients.
Some Disadvantages of a Delaware Incorporation
While the filing fee to create an entity is lower in Delaware than Minnesota ($89 vs. $135), Delaware has a franchise tax that will apply to some companies. In addition, an entity incorporating in Delaware is required to have a Delaware registered agent to accept service of process. Year after year this cost will accrue, and may be a permanent thorn in the side of an entity that receives no tangible benefit from a Delaware incorporation.
Delaware law establishes a higher legal standard than Minnesota for making distributions to shareholders. See Section 170, Delaware General Corporation Law. This higher threshold may constrain a Board of Directors from making distributions.
Finally, most Minnesota lawyers are simply less familiar with Delaware corporations and the Delaware General Corporation Law. While this may be less of a disadvantage at the incorporation stage, it can be a major burden when a Minnesota-based Delaware company is engaged in transactions or litigation that require an understanding of the intricacies of Delaware law.
Conclusion
Incorporating in Delaware will be appropriate for a small universe of Minnesota-based companies. For the typical entrepreneur with a Minnesota domicile, a Minnesota office, and no aspirations of going public, however, the Minnesota Business Corporation Act is usually an appropriate and preferable framework for corporate formation. If you and your company are seeking legal representation in connection with the formation, acquisition, or merger of a Minnesota or Delaware company, contact any of the corporate law attorneys of Trepanier MacGillis Battina P.A.
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About the Author:
Minnesota business attorney James C. MacGillis has organized and currently represents companies incorporated in Minnesota, Delaware, Wisconsin, Illinois and other states. Jim frequently advises clients on business acquisition and sale issues. Jim may be reached at 612.455.0503 or jmacgillis@trepanierlaw.com. Trepanier MacGillis Battina P.A. is a Minnesota business startups law firm located in Minneapolis, Minnesota.