Where Should You Incorporate Your Tech Company?
This is fourth in a series of blogs on launching, growing and ultimately selling a technology company, with a corporate finance focus. Topics will include cap structures, equity plans, financing, corporate partnering, board matters and how to achieve a successful exit.
Last post I talked about when to incorporate, now let’s talk about where. It’s an easy question to answer if you are based in the US (hint: incorporate in the US!). The most common states for incorporation are South Dakota, Wyoming, Nevada and Florida (each having no state-level income tax), and Alaska, New Hampshire, Montana and Delaware (each having no state-level sales tax).
Advantages of Incorporating in the US
Most technology entrepreneurs choose Delaware (legal home to 50% of all publicly-traded companies in the US and 63% of all Fortune 500 companies) or Nevada because of the favourably drafted corporate statutes. These statutes contain flexible corporate laws, better liability protection, less aggressive shareholder rights and, in Delaware’s case, a judicial system that includes a business division with deep knowledge of corporate matters. They are “good for business” states.
Notably missing from this list is California, home to the largest number of start-ups in America. California doesn’t make the list of favourites because of higher taxes (which might catch you anyway if you are operating there), greater shareholder rights (and thus greater liability) and a more aggressive securities regulatory regime (making financing more expensive). You can operate in the Valley without incorporating in California so no need to give up easy access to Napa.
True North Strong and Free, True?
But what if you are operating on the Canadian side of the border or forming your start-up outside North America? Should you incorporate in your home jurisdiction or in the US? Some people will tell you to incorporate in the US because of greater access to venture capital (true), better valuations (mostly true) and better valuations at exit (sometimes true). However, there are issues with incorporating in the US if you intend to build your company in Canada or in another country.
Incorporating in an American state but operating outside the US creates a double admin burden that you really don’t need in the early stages. It means you need to comply with both US and Canadian (or other home jurisdiction) securities laws plus file corporate taxes in two jurisdictions. In addition to these issues, there are also employment, immigration, accounting as well as other tax and legal complications. This is an expense and a double regulatory burden that no early stage company needs.
Advantages of Incorporating in Canada
Canada, and in particular British Columbia where I call home, offers a number of incentives for start-up technology companies. Those incentives have real value which is lost if the company is US-incorporated. These include IRAP (and other government) grants, access to the SRED program and the Small Business Venture Capital Act tax credits. When the angel markets have been challenged, the SRED program has often been the most active and dependable “angel” around. And the SBVCA 30% tax credit has become table stakes when raising angel and venture capital locally. These incentives have attracted technology entrepreneurs from around the world who want a home base in North America. Favourable immigration policies, especially for commonwealth nationals, have also helped.
My advice to entrepreneurs on where to incorporate comes down to a few simple questions:
- Where do you plan to live and build your team, here in BC?
- Where do you expect to be able to raise your initial capital, locally in BC?
- Do you want or expect to access government grants, claim for SREDs and take advantage of the SBVCA tax credit?
If the answer to all three is “yes”, then incorporate in BC (provincially) or under the Canadian statute (federally). If you really have your heart set on being a US company, then fully commit. Move to the US and actually build your company there. Be careful not to let incorporation become the tail that wags the dog – wherever you intend to build your business is where you should incorporate.
OK, But What About the Money?
Entrepreneurs always ask this question: If I set up in Canada or elsewhere does it close any financing doors? The simple fact is that good companies will attract US venture capital. Just look at the booming start-up community in Israel, which pound for pound punches way about its weight and US venture capital recognizes this. Setting up here in Canada has certainly not hurt Hootsuite, Shopify, Desire2Learn, BuildDirect, D-Wave and Kik, to name just a few.
And anyway, it’s possible to move your company to the US (re-domiciling it) should future investors require — so you can take this objection off the table. But if you really want or need to, you can always leave the parent company incorporated in Canada or your home jurisdiction and form an operating subsidiary in the US with a physical presence (if that actually matters, it’s far less important in the world of virtual companies) to employ your American staff and deal with any cross-border employment issues.
The Bottom Line
Deciding where to incorporate means planning carefully and getting the right advice. Incorporate your company where you start your business. Focus on building your team and proving out your business model and actively build connections both at home and in the US. Funding and buyers will be there if you build a successful company.
Next up, some simple corporate structuring tips to avoid future pain and expense.
David practiced corporate finance law for 20 years representing numerous BC-based technology companies before retiring to co-found a venture capital fund where he was a partner and portfolio manager for ten years. He now provides corporate finance/M&A advice to a portfolio of early stage companies with a view to growing them to the point they are ready to exit, and then leading that process.
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