|February 19, 2014|
Previously published on February 18, 2014
Delaware is the state of incorporation for a majority of venture-backed and publicly-traded corporations. The Delaware courts have developed considerable expertise in dealing with corporate issues and there is a substantial body of case law construing Delaware law. As a result, investors are familiar and comfortable with Delaware. Delaware law and courts are also deferential to directors and management, looking skeptically on frivolous stockholder litigation and providing protections against hostile bids.
For all of its benefits, Delaware has convoluted methods of calculating the franchise tax payable by corporations for the privilege of being incorporated in the state, which can result unnecessarily high bills without some advance thought and planning. Of course, large corporations with substantial assets will have significant franchise tax obligations (up to $180,000), but there is no reason for smaller corporations to be getting stuck with large bills.
Under one method, a corporation can pay franchise tax based on its authorized number of shares. This option provides for low franchise tax for corporations with few authorized shares, but is impracticable for corporations with a large stockholder base or multi-class capital structure. The amount of franchise tax due as shown on the bill sent out by the State of Delaware is calculated under this method, but is subject to recalculation under the alternative “assumed par value” method prior to payment.
Under the “assumed par value” method, a corporation calculates franchise tax based on a combination of its gross assets, authorized shares, issued shares, and par value, with the ratio of issued shares to authorized shares being especially important. For example, a corporation with $10,000,000 in assets and 5,000,000 issued shares of common stock, with a par value of $0.01 per share, would have a franchise tax bill of $7,000 if it had 10,000,000 authorized shares of common stock, but only a $4,200 bill if it had 6,000,000 authorized shares of common stock. It is possible that the additional 4,000,000 authorized shares serve no practical purpose for this corporation, other than to increase the franchise tax bill.
Corporations with less than $1,000,000 in assets and a single class of stock should be paying $700 or less in annual franchise tax under most circumstances, and it is important for all corporations to ensure that there aren’t too many authorized, but unissued shares at any time. This is a crucial consideration in connection with setting up a corporation and should be revisited whenever there are changes in a corporation’s capital structure.