Questions

Should we dissolve the S Chapter Corp and do a Delaware C?

We've been building our product here in Kentucky. It is a cloud based service. We incorporated as a S chapter corporation. Now we are ready to take on investors. Should we dissolve the company here in Kentucky and setup a chapter C corporation in Delaware?

3answers

We answer this question quite often at www.LawTrades.com as Delaware does offer C-corps the greatest flexibility in terms of structuring boards of directors, stock issuance and preference, and voting rights. It also provides the broadest privacy protections. For instance, it doesn’t require director or officer names to be revealed on formation documents. For these reasons, many investors prefer companies that have been incorporated in Delaware as C-corps.

On the other hand, you’ll be required to file periodic reports in Delaware, in addition to the state where you do business. Moreover, Delaware requires that you regularly submit franchise taxes, even if you’re paying those taxes to the state/s in which you are already doing business.

Many companies don’t require C-corp status; in fact, incorporating as a C-corp for some companies could be detrimental to their overall financial interests. Filing as an LLC with subchapter S selection or some other type of entity that’s not a C-corp - especially when there’s no expectation of going public - is often best done in the state where the company is conducting business. Frankly, where you’re incorporated isn’t going to affect the decisions of most people, with the exception of perhaps investment bankers and investors who are considering a fast growth C-corp that is planning on a future IPO - high tech or otherwise.

If you’re a high tech startup with no reason or plans to go public, you should seek legal advice from a home state attorney to explore your in-state options.

Again, these are generalities and aren’t intended to provide specific legal advice or delve into the differences between the corporate laws of different states. I would, however, again emphasize that very often the state in which the business is located is often the best state in which to incorporate.

In you need further assistance incorporating your startup and evaluating in which state would be the best fit, please feel free to check out www.lawtrades.com. You can also message me directly and I’d be happy to answer any further questions you have regarding your company’s formation.


Answered 4 years ago

I deal extensively with corporate and securities law for startups, who face the question of what entity type and tax elections to make quite often. The answer to your question is that you may HAVE to make the switch, as S-Corp status may no longer be an option if you are taking on investors. It depends on how many investors you will have and what type of investors they will be. There are a number of requirements in order to be able to elect and maintain S-Corp status. Among them are that you must have less than 100 investors, and those investors must be individuals (or certain types of trusts). If you take on investors that bust either of those requirements (or any of the others not mentioned here), then you would no longer be allowed to elect S-Corp status. If we assume you have the option to keep S-Corp status after you take on investors, we have to look at both investor interests and your business interests. For investors, the question becomes whether they want to be taxed as an S-Corp. There are plenty of reasons that they would not (and would prefer C-Corp taxation), but everyone is different. They might be fine with it. From a business perspective, in order to maintain S-Corp status, you can only have ONE class of stock. This means that your investors would get the same shares as you have, with the same voting rights, etc. However, it is common business practice, especially in a major financing round, for investors to get a new series of preferred shares (e.g. Series A) with rights different than the common shares. In order to do this, you would have to create a new class of shares, which would also require you to switch to C-Corp status (as you would no longer be eligible for S-Corp status). All that said, this is just informational, and I am happy to talk further about your specific situation.


Answered 5 years ago

Yes, you probably need to switch from a S-corp to a C-corp (for the reasons the other answer already addressed). But whether you need to switch from Kentucky to Delaware is a separate question--depends upon the type of investors you're going after (and their end game).

However, you probably wouldn't want to dissolve the Kentucky company and set up a new company in Delaware--that would have too many tax consequences for you. What you'd do is a merger, where you are merging your current Kentucky company into one you create in Delaware. That's not a DIY proposition--you'll want to a work with an attorney & a CPA who are experienced in mergers.


Answered 5 years ago

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