By Joshua D. Freeman
Knowing the type of entity you want to form for your business is the first step, next you need to decide where to organize the business. Thankfully, this question does not take as long to discuss. There are two popular answers to this question: the state where you live, or Delaware.
Choosing Your Home State
Organizing your business in your home state is almost always the right choice. First off, your home state is often the most convenient. Second, if you form the business in your home state, you will not have to register it as a foreign entity in able to do business where you live. Third, by registering in your home state you will not have to hire a commercial registered agent to serve in the state of formation and save a hundred or so dollars a year. Ultimately, the convenience and additional administrative cost will often make it worthwhile to form your entity in your home state.
Choosing Delaware or Beyond
With that said, there are a couple factors that might lead you to choose to form your business outside of your home state. The first reason is if you plan to raise money to fund your business from the outset. The second is if your state has unfriendly laws for business owners. And the third reason is associated with owner liability issues with limited liability companies, which we will talk about later.
If you plan to raise money for your business or an investment fund from investors from different parts of the country or world, you will want to choose a well-respected, well-established state. These states provide a higher degree certainty of how the business laws will be applied. Of all the states, Delaware best fits that description. Delaware has business friendly laws and filing procedures, and it has an extensive, established and respected body of business law. For these reasons, Delaware is the most popular state to organize a business—you will never hear an investor complain about your business being filed in Delaware.
Unfortunately, some states have legal systems that are unfriendly for startups and other businesses. Since that is the case, it is common for entities to organize in a different state (usually Delaware) to avoid those unfriendly laws that might discourage investment opportunities. Thankfully, the vast majority of states are adopting uniform corporate or limited liability company statutes, often patterned after Delaware’s laws. For this reason, there is less and less need to organize in other than your home state.
The state’s laws regarding charging orders is one of the issues that regularly influences where owners decide to set up an LLC. Charging orders get down to the essence of what happens when an owner of an entity is sued and has judgment entered against him or her.
There are two scenarios of how this plays out when this happens: first, the judgment creditor is allowed to foreclose on and take over the ownership of the owner’s interest in the business; and second, the judgment creditor just receives the monetary distributions from the business that would otherwise flow to the owner until the judgment creditor is paid in full, and then afterward the financial benefits of the company are restored to the owner. In the second scenario, the owner continues at all times to own the interest in the business and continues to control the management and maintains its voting rights in the entity. The owner only loses his financial rights in the company for the period of time it takes to pay off the judgment. The limited rights provided to the judgment creditor in this second scenario is what is called a charging order.
You should seek out states that give judgment creditors charging orders and not foreclosure rights. Charging order laws are not uniform from state to state. Understanding your state’s specific laws and how sensitive you are to asset protection type issues will inform whether you should look into filing in a state outside your own if your state does not have favorable charging order laws.
There is no crystal clear answer to where to file your business entity, but usually the two best options are either your state or in Delaware.