March 5th, 2020

Home Sweet Home: Choosing the Right State(s) to Form and Operate Your Business

Posted in:      Tagged: ,

Author: Andrew L. Schwartz, Kristin A. Neubauer

Washington Region

When forming a new business, one of the first questions typically asked is: In which state should the business be formed? An Internet search suggests that the best place to form a new business may be in Delaware, but that may not actually be true for you.

Why Delaware Might Not be the Right Place to Form Your Business

Historically, forming a business in Delaware had certain advantages, namely a specialized business court and a robust history of cases to rely on in resolving business disputes. However, those advantages have largely disappeared as other states have adapted their court systems to include specific business litigation tracks that streamline review of business disputes and have greatly expanded the case law addressing issues between businesses. In light of this equalizing of relative benefits, in most cases, the best state to form your new business is the state where your company will primarily be conducting its business.

First, most, if not all, states require businesses to pay annual fees for the privilege of conducting business in that state. By forming the business in the same state that it will conduct most of its business, the business will only pay one state’s annual filing fees. If the business is formed in one state, but conducts its primary business in another state, then the business will likely also have to qualify to do business in that state and pay annual filing fees in both jurisdictions – even if the business does not conduct any business in the formation state. For example, if you form a business in Delaware, but are actually doing business in Maryland, then you will have to qualify the business in Maryland and pay the annual fees for both Delaware and Maryland. In contrast, if you initially form the business in Maryland and conducts primary business in Maryland, then you are only subject to paying the annual fee in Maryland.

Second, all states require that a business have a resident (or registered) agent, who must be a resident of the state in which the business was formed. The purpose of the resident agent is to accept service of process (i.e. lawsuits) on behalf of the business in the state. While commercial resident agents are available, they charge fees for providing this service. If a business is formed in the state where it primarily does business, then the business is more likely to have an owner or employee who can fulfill this role without incurring additional costs of hiring a commercial resident agent.

For these reasons, among others, it is imperative to think strategically about the best location to form a new business before actually filing the formation documents. By doing so you can minimize the administrative costs in starting the business and can avoid having to file additional and costly paperwork to protect the business’s legal and equitable rights.

Qualifying Your Business in Other States

Businesses that conduct business in more than one state may need to qualify their business in the other states where it conducts its business activities. Unfortunately, determining whether a company is doing enough business in a state to require the need to register/qualify to do business in that state can be complicated to answer. Most states do not actually define what “doing business” in their state means. Rather, most states merely carve-out specific types of activities that are excluded from the “doing business” definition. States will also sometimes require that a business register its business with the state’s taxing authority, but the business may not otherwise be required to qualify to do business with the state’s other agencies.

Adding further complexity, if a business does not qualify to do business in a state where it should have, then the state can likely assess civil penalties against the business and may be able to take other formal action for failing to comply with the state’s laws. Additionally, the business will likely be prohibited from using the state’s resources, such as the state’s court system, in the event the business needs judicial intervention to resolve a contract or other business dispute. However, it should be noted that, although the business may not file a lawsuit in such instance, if the business is sued in the state, even though it may not be qualified to do business there, then it may still defend the lawsuit without being qualified to do business.

Prior to forming a new business, you should consult with an attorney to discuss the type of business you should form as well as the state in which the business should be organized and whether you are required to qualify/register your business in another state.