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Delaware versus Washington: Where should I incorporate my startup?

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This a chart comparing some of the high-level pros and cons of being incorporated in Washington versus Delaware. For more information, visit www.theventurealley.com.

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Delaware versus Washington: Where should I incorporate my startup?

  1. 1. - 1 - November 16, 2010 Delaware versus Washington: Where should I incorporate my startup? Below is a chart comparing some of the high-level pros and cons of being incorporated in Washington versus Delaware. For more information, visit www.theventurealley.com. Annual Cost WASHINGTON POSITION DELAWARE POSITION PRO/CON ANALYSIS Companies incorporated in Washington pay only an annual license fee of $69. Delaware corporations are charged annual fees (called a “franchise tax”) based on total assets and authorized shares, which can be up to $180,000 (the maximum). Washington is far less expensive. In addition, the company may be required to pay a registered agent in Delaware. Limitation of Director Liability WASHINGTON POSITION DELAWARE POSITION PRO/CON ANALYSIS Companies may release the personal liability of directors to the corporation and its shareholders for monetary damages for acts or omissions as directors, except in specified circumstances involving: (a) intentional misconduct or a knowing violation of law; (b) unlawful distributions; or (c) transactions from which the director personally receives a benefit in money, property or services to which Delaware allows release of director liability, subject to five exceptions – three of which generally track those of the Washington statute – but the Delaware statute also adds two more broad exclusions from the protections afforded: (a) breaches of the duty of loyalty; and (b) acts or omissions not in good faith. Washington provides superior liability protection for directors because there are fewer and narrower exceptions to the scope of the permitted release. As demonstrated in In Re The Walt Disney Company Derivative Litigation [http://www.potteranderson.co m/news-firm-42.html], directors of Delaware corporations are subject to claims that their actions breached the duties of loyalty or good faith, neither of which is defined by statute or well articulated by judicial decisions. By contrast,
  2. 2. - 2 - the director is not legally entitled. Washington is more clear. Washington exceptions use terms such as “intentional,” “knowing” and “personally received,” which are much narrower and better defined by common law. Director and Officer Indemnification WASHINGTON POSITION DELAWARE POSITION PRO/CON ANALYSIS Companies may agree to indemnify directors and officers for expenses, judgments, fines and other payments in actions brought by third parties, and reasonable expenses incurred in connection with actions brought by shareholders in the name of the corporation (so- called “derivative actions”). The ability of a Delaware corporation to indemnify its directors and officers for payments in non-derivative actions is subject to a determination that the person acted in “good faith” and in a manner “in or not opposed to” the company’s best interests. Washington provides superior indemnification protection for directors and officers because the exceptions to the indemnity powers of a Washington corporation in derivative and non-derivative actions are much narrower and better defined than under Delaware law. Reliance on Delaware Case Law WASHINGTON POSITION DELAWARE POSITION PRO/CON ANALYSIS There are fewer court cases construing the Washington Business Corporation Act. In the absence of Washington case law or clear statutory guidance on a particular point of Washington corporate law, Washington’s Supreme Court and lower courts have exhibited a pattern of regularly referring to Delaware case law as relevant legal authority. Delaware corporations are subject to, and have the benefit of, a large body of Delaware corporate law court decisions, including more detail on governance issues and in the merger and acquisition context, where greater predictability of legal consequences can be important. At the same time, Delaware case law has also created several non-statutory directors’ duties – such as the duty of candor – which is not well-defined and has not yet Delaware courts have greater experience with handling cases interpreting corporate law and construing director fiduciary duties, and this body of case law and judicial experience is the main reason cited in support of reincorporating from Washington to Delaware; however, Washington judges can and often do use Delaware case law to help guide their Washington corporate law decisions. The traditional view that Delaware courts tend to
  3. 3. - 3 - been imposed upon directors of Washington corporations. rule more “favorably” to corporations and their fiduciaries has come into question in recent years, particularly as they have articulated new “duties” as a basis for fiduciary liability. Shareholder Approvals WASHINGTON POSITION DELAWARE POSITION PRO/CON ANALYSIS Amendments to the articles of incorporation, a merger, consolidation, or sale of all or substantially all of a corporation’s assets other than in the usual course of business, must be approved by two-thirds of the outstanding shares, unless the articles of incorporation provide for a lesser vote. Amendments to the certificate of incorporation, a merger, consolidation, or sale of all or substantially all of a company’s assets other than in the usual course of business, must be approved by a majority of the outstanding shares. A Washington corporation may elect to lower (in its articles of incorporation) the voting threshold for these corporate actions to a majority so there would be no difference between Delaware and Washington. On the other hand, the higher approval required for mergers of Washington companies may work in the company’s favor by enabling it to insist on a higher price, or could have a mild antitakeover effect, in the event of a proposed acquisition. Action by Less-than-Unanimous Written Consent WASHINGTON POSITION DELAWARE POSITION PRO/CON ANALYSIS If provided in the articles of incorporation, shareholders may take action by less-than- unanimous consent. Action is effective upon receipt of the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote were Stockholders may take action by less-than-unanimous written consent, unless otherwise provided in certificate. Action is effective upon receipt of the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote were present. Delaware requires only one, after-the-fact notice to stockholders, while Washington requires two notices (one at the time shareholder approval is sought and the other after-the-fact informing shareholders that such approval has been obtained).
  4. 4. - 4 - present. Washington requires two separate notices to shareholders: (i) the first when shareholder consents are being sought, and (ii) the second when the company has received sufficient votes necessary to approve the proposed action. “Prompt” notice of the action taken must be sent to all stockholders who did not consent in writing and who would have been entitled to notice of a meeting. Antitakeover Statute WASHINGTON POSITION DELAWARE POSITION PRO/CON ANALYSIS 10% shareholders are prohibited from taking certain actions for a 5-year period after acquiring a 10% interest. Such actions include engaging in mergers or asset sales with the “target” company. The only exception to this rule is where the shareholder received board approval of the share acquisition or the proposed transaction prior to acquiring the 10% interest. There is no ability to “opt out” of this statutory provision. 15% shareholders are prohibited from taking certain actions with the “target” company for a 3-year period after acquiring the 15% interest. This restriction does not apply where the shareholder received board approval of the share acquisition or the proposed transaction prior to acquiring the 15% interest, or where the proposed transaction is approved by two-thirds of the voting shares not owned by the 15% shareholder. Under certain circumstances shareholders of Delaware corporations can “opt out” of this antitakeover statute entirely. Washington’s antitakeover statute does not provide an ability to “cure” the transaction prohibition after a non- approved 10% share acquisition – this could make an acquisition of a company more difficult in some circumstances, which could be viewed as favorable or unfavorable, depending on one’s perspective. In any event, a company would likely be subject to the Washington statute even if it were incorporated in Delaware, because it is headquartered and has a significant presence in Washington.
  5. 5. - 5 - Dissenters’ Rights WASHINGTON POSITION DELAWARE POSITION PRO/CON ANALYSIS Shareholders can dissent from, and upon perfection of dissenters’ rights obtain the fair value of their shares in, certain corporate actions, including mergers, sales of all or substantially all the assets of the company and articles amendments that effect a redemption or cancellation of all of the shareholder’s shares. Dissenters’ rights are generally available only in connection with cash mergers, unless otherwise provided in the company’s certificate of incorporation. Dissenters’ rights are not available in asset sales or amendments to the certificate of incorporation. Delaware law provides dissenters’ rights in fewer circumstances, which could make it easier to acquire a Delaware corporation (because merger agreements typically limit the percentage of shares that can dissent as a condition to closing the merger, and this extra hurdle to closing would not exist if there are no dissenters’ rights as to a particular form of transaction).

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