Facebook, Twitter, Visa, MasterCard, Verizon, Tesla, Chrysler … Did you know that two-thirds of Fortune 500 companies are registered in Delaware? Yes, you read that right. This small state has become a major player in the world of corporate incorporation. But here’s the surprising part – only one of those companies, DuPont, is physically based in Delaware. So, how did Delaware manage to attract such a massive number of corporations?
The answer lies in history. Back in 1888, Delaware made a smart move by adopting New Jersey’s laws on holding companies. At that time, New Jersey was the go-to state for businesses due to its relaxed corporate structure regulations. This move paid off for New Jersey, as it attracted corporations and generated significant state revenue. However, things took a turn in 1913 when New Jersey introduced stricter regulations. This sudden change prompted many corporations to look for a friendlier environment and found it in Delaware. The first state had copied New Jersey’s laws and quickly positioned itself as a corporate favorite state.
Since then, Delaware has been the preferred choice for companies looking to incorporate. And it’s not just because of its history. Delaware has worked hard to maintain its reputation as a business-friendly destination. It offers numerous advantages, such as a well-established legal system, a dedicated Court of Chancery that specializes in corporate law, and a business-friendly tax structure. Here is how and why:
Simplicity and Anonymity:
Setting up a company in Delaware is incredibly straightforward and hassle-free. Entrepreneurs can establish a company remotely through a simple online process, often completing it within minutes. Unlike other states, Delaware doesn’t require extensive verification or identification checks. While this simplicity is a major draw for businesses, it also raises concerns about potential illegal activities and money laundering. To address these concerns, the United States passed the Corporate Transparency Act in 2020, which requires company owners to provide photo identification. In an attempt to avoid full transparency, Delaware has proposed a new system that allows entrepreneurs to register their companies anonymously at the state level while disclosing their identities to the federal government within a month.
Delaware’s legal industry, particularly the Delaware General Corporation Law, plays a pivotal role in the state’s economy. The unique legal culture in Delaware, known as the Delaware Way, emphasizes cooperation and collaboration among lawyers. This system has resulted in the development and protection of corporate laws that greatly benefit businesses. Delaware’s ability to adapt and stay ahead of the game is evident in its response to challenges from other states. For instance, when South Dakota attempted to attract financial institutions by eliminating interest rate caps, Delaware swiftly invited prominent Wall Street names to rewrite financial rules behind closed doors. This proactive approach helped Delaware maintain its position as the preferred destination for credit card companies.
The Chancery Court:
Delaware’s Chancery Court is a specialized court system for business cases, known for its expertise in handling fiduciary relationships. The court operates as a court of equity, where judges act as both the rulers of the law and the finders of facts. This unique setup allows for detailed opinions that not only resolve current cases but also provide guidance for similar situations in the future. The reputation of the court, coupled with the expertise of its ten members, has made it a preferred choice for resolving business disputes. This, in turn, has led many venture capital firms to prioritize funding Delaware-based companies, further solidifying the state’s position as a legal home for entrepreneurs.
Delaware’s tax policy, commonly referred to as the Delaware loophole, offers companies a way to minimize their tax burdens. By funneling profits through Delaware holding companies, businesses can avoid taxes in other states. For example, Delaware’s tax laws do not impose taxes on intangible assets such as trademarks and slogans. This loophole allows companies to categorize their profits as intangible assets, effectively reducing their tax liabilities. However, it’s important to note that the Delaware loophole has been exploited in the past, as seen in the infamous Worldcom case. The company paid its Delaware holding company $20 billion over three years for an intangible asset called “management foresight.” By claiming that their profits were a result of superior management skills, Worldcom avoided taxes in other states. However, it was later revealed that Worldcom was involved in massive accounting fraud, leading to the company’s collapse and its CEO’s imprisonment..
Delaware’s appeal to businesses can be attributed to its simplicity and anonymity in company formation, a legal system that prioritizes cooperation and collaboration, a specialized court system for business disputes, and tax advantages. While Delaware’s dominance raises concerns about transparency and tax fairness, efforts are being made to address these issues. As the first state of the United States, Delaware continues to pave the way for corporate incorporation and remains a top choice for businesses looking to establish their legal home.