Most startups incorporate as a Delaware C corporation, even though they have no actual presence in or relationship to Delaware. Delaware is a common choice for a variety of reasons, including investor familiarity with Delaware law, certain legal protections afforded the Company and its officers and directors, procedural efficiencies (such as filing Charter amendments) and a well-developed body of corporate law that can lead to fair and predictable outcomes.
However, there can be benefits to incorporating in other jurisdictions as well. The decision to form a Delaware C Corporation or a different type of entity should be carefully discussed with your Company's lawyer and accountant.
Alternatives to Delaware C Corporations:
If a startup chooses not to incorporate as a Delaware C corporation, the common alternatives include (1) S Corporation, (2) corporations in other states (such as California), or (3) limited liability companies (such as in Delaware, California, or other states).
(1) S Corporations:
An S corporation is a corporation that elects to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. In general, S corporations do not pay any federal income taxes. Instead, the corporation's income or losses are divided among and passed through to its shareholders. The shareholders must then report the income or loss on their own individual income tax returns. Essentially, an S corporation is a corporation that is taxed like a partnership. Theoretically, this avoids double taxation: taxation at the corporate level for corporate earnings, and then at the individual level when such earnings are distributed to the owners of the corporation.
However, the lengthy requirements for an S corporation election are often not suitable for a startup company, and the S corporation benefits are rarely gained in practice. For example, a corporation that seeks to be an S corporation can have no more than 100 shareholders. This may be difficult if the startup company has a large number of angel investors, and certain rules must be considered for trusts and estates when counting "shareholders." Secondly, the corporation can have only one class of stock (e.g., only common stock). Since most startups intend to issue preferred stock to investors, they will not be able to meet this requirement. Additionally, any individual who holds stock in an S-corporation must not be a resident alien. This will restrict the Company's ability to issue stock to certain foreign individuals. Thus, most startup companies are not S corporations.
To become an S corporation, the Company must file Form 2553 with the IRS. Typically, an S corporation seeks to be treated as such when it does not meet the statutory guidelines to be one, and further paperwork/filing may not be required. These filings should be coordinated with the Company's lawyer or accountant.
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/S-Corporations(2) Corporations of Other States:
A Company can also incorporate in another state. California and Nevada are popular states for incorporation outside of Delaware. However, since most startup investors require a startup company to be located in Delaware, a corporation of a different jurisdiction may have to "reincorporate" into Delaware as a condition of investment. Reincorporating can cost more than $5K - $10K in legal bills.
(3) Limited Liability Companies (in any state):
A limited liability company ("LLC") is a form of a private limited company. This entity combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. LLCs, like corporations, can be formed in any state in the United States and will be governed by that state's local laws. Whereas corporations are owned by "stockholders," partnerships are owned by "members." Many companies choose to form LLCs because they can be beneficial from a tax perspective, depending on the specific factors unique to the business. To form an LLC, one member must file a Certificate of Formation in the state in which the company would like to incorporate. All members should sign a Limited Liability Company Agreement. Generally, this private LLC Agreement will dictate the structure of an LLC. From a taxation or organization standpoint, the structure can be more flexible than that of a corporation, which will be more dictated by statute. However, like a non-Delaware corporation, most investors will not invest in a startup company that is an LLC and will require the LLC to convert to a Delaware corporation before dispersing funds. This may require significant legal fees.
Other resources:
http://www.quora.com/Why-do-most-technology-startups-incorporate-in-Delawarehttp://www.quora.com/Whats-the-advantage-of-incorporating-a-startup-in-Delaware-for-a-closely-held-companyhttp://www.quora.com/Are-there-any-other-clear-advantages-to-a-Delaware-C-Corp-if-youre-not-planning-to-raisehttp://www.startupcompanylawyer.com/2009/03/12/what-type-of-entity-should-i-form/