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As discussed in detail in our earlier article, local and foreign entrepreneurs usually chose Delaware as home for their business venture in the U.S. There are multiple reasons why Delaware has become the favorite jurisdiction of numerous businesses in the U.S., many of which are listed here on the official website of the state of Delaware, and many more can be found by conducting a simple internet search. This makes picking a jurisdiction relatively straightforward even for entrepreneurs who are just getting to know the U.S. market. However, after choosing Delaware as the incorporation state, each entrepreneur stumbles upon a relatively more complex question: which Delaware legal entity type to use?
As it often is the case, the answer is a legal cliché: it depends. The optimal Delaware legal entity type for a business always depends on its structure, model and long-term goal. Therefore, in order to determine the most suitable type of legal entity for you, we would need to have sufficient knowledge about your planned business. However, for those seeking to make this decision independently, below we cover the most important features of the two legal entities which rightfully seem to be the only choices in Delaware – a limited liability company and a c-corporation. Considering and weighting these items will certainly make the process of choosing the Delaware legal entity type for your business much easier. Even though the chart below is a great place to start and it might answer the most pressing questions, please mind that this article is neither legal advice nor should be treated as an exhaustive description of all applicable laws.
LIMITED LIABILITY COMPANY |
C-CORPORATION |
||
ESTABLISHMENT |
Process | Straightforward, can be done entirely online. | |
| Fee | $90 | $89 | |
| Registered Agent | Must be appointed in the State of Delaware. | ||
| Employer Identification Number | Can be obtained from the Internal Revenue Service. | ||
| Bank Account | Can be opened for the entity. | ||
| Mandatory Documents | Certificate of Formation | Certificate of Incorporation;
Bylaws |
|
| Optional Documents | Operating Agreement (highly recommended);
Indemnification Agreement(s); Other. |
Action of Incorporator;
Resolutions of the Board of Directors; Founders’ Agreement; Stock Purchase Agreement(s); Indemnification Agreement(s); Employee Stock Option Plan; Other. |
|
GOVERNANCE |
Law | Delaware Limited Liability Company Act | Delaware General Corporation Law |
| Document | Operating Agreement | Certificate of Incorporation and Bylaws
Any change to the Certificate of Incorporation must be recorded with the Secretary of State of Delaware. |
|
| Managing Body | All members or appointed manager(s) (as set forth in the Operating Agreement). | Board of Directors and officers (in some situations Stockholders’ approval is mandatory). | |
| Flexibility | Very flexible – the Operating Agreement is an internal agreement between members of the LLC. Freedom of contracts allows members to create custom rules that fit their needs. | Flexible within the framework of Delaware General Corporation Law – Certificate of Incorporation and Bylaws must be in line with the rules set forth in the Delaware General Corporation Law. Some custom arrangements may only be implemented through an internal Shareholders’ Agreement. | |
FIDUCIARY DUTIES |
May be limited in the Operating Agreement – members may be able to promote their own interest above the interest of the LLC. | Members of the Board of Directors have a duty of care and a duty of loyalty to the corporation. | |
OWNERSHIP |
Structure | Percentage of interest or ownership units – as set forth in the Operating Agreement. | Shares. Multiple classes of stock may be created and issued to different investors. |
| Employees | Ownership-like benefits can technically be created in the Operating Agreement, however it is not common in practice. | Employee Stock Option Plan is a commonly used instrument to grant stock options to employees. | |
| Transfer and assignment | LLC interest is assignable except as provided in the Operating Agreement. | Stock is transferrable, but subject to restrictions on transfer and ownership of securities. | |
DISTRIBUTION OF INCOME |
As set forth in the Operating Agreement (or based on the agreed value of the contribution made by each member to the LLC). | Income may be distributed by paying dividends to stockholders. | |
LIABILITY |
Personal | Limited.
Members are not personally liable for the obligations of the LLC. Liability of a member is limited to the amount contributed to the LLC by that member. Managers may be personally liable if such liability is provided in the Operating Agreement. |
Limited.
Shareholders may become personally liable for the obligations of the corporation through the use of the “piercing of the corporate veil” doctrine. Directors may be personally liable in case of breach of fiduciary duties. |
ANNUAL DELAWARE OBLIGATIONS |
Annual Report | None | Mandatory |
| Fee | $300 | Is calculated based on the
number of authorized shares ($175 – $200,000) or total gross assets, total issued shares and number of authorized shares ($400 – $200,000) |
|
OPERATING IN OTHER STATES |
Authorization | May be authorized or registered to do business in other states | |
PRIVACY |
No information about members or managers of LLCs is currently collected by the State of Delaware. | No information about shareholders of corporations is currently collected by the State of Delaware.
Directors – all Directors must be listed in the Annual Report. Officers – one officer must be included in the Annual Report. Information included in the Annual Report is publicly available for a fee |
|
FINANCING |
Initial Capital | Member contributions (cash, property, services), promissory notes, loans and other mechanisms as set forth in the Operating Agreement. | Purchase of shares, loans and various corporate investment instruments such as promissory notes, loans, convertible loans and SAFEs. |
| Investments | Usually not preferred by investors. | Preferred by investors – multiple investment instruments are available to investors such as convertible loans, SAFEs and stock purchase instruments. | |
FEDERAL INCOME TAX |
Default Treatment | Single-member LLC: disregarded (flow-through) entity – no tax at the entity level, however all profits (or losses) of the LLC must be reported on the member’s tax return;
Two-member LLC: partnership – no tax at the entity level, however members pay taxes on their share of the profits of the LLC on their personal tax returns. |
C-Corporation – flat 21% corporate income tax. |
| Alternative Treatment | S-Corporation;
C-Corporation. |
S-Corporation | |
