How to Form a Delaware Corporation (Correctly)

Forming a Delaware corporation is pretty straightforward for those who have done it many times before.  You just have to follow the steps.  Skipping any of them may hurt the founders later on, when they find out that they are not actually the shareholders of their company.  These formation mistakes are typically revealed at the time when the company is undergoing a legal due diligence in advance of a financing event.  How embarrassing it is to have to deal with legal clean-up at that time!

So, I decided to write down the steps I take to ensure that my clients are properly set up from the get go:

Step 1.  Check name availability with the Delaware Division of Corporations.

Step 2.  (Optional but recommended if the company will be using its name as a trademark): Check whether the name is available as a trademark with the USPTO.  Several of my clients had to change their company's name because it was already used as a trademark by some other business.

Step 3.  Obtain a registered agent.  I typically choose Harvard Business Services.  They charge only $50 per year.

Step 4.  File Certificate of Incorporation with the Division of Corporations. Startups authorize anywhere between 5 million and 10 million shares of common stock.  That number has to be included in the Certificate of Incorporation.  It is signed by an Incorporator (usually, an attorney doing the filing).  Attorneys typically have their own forms of the Certificate that they prefer to work with.

Step 5.  Once the Certificate has been filed, prepare an Action of Incorporator, whereby the Incorporator (i) adopts the initial Bylaws, (ii) elects the initial Board of Directors, and (iii) resigns.  This is a simple but yet an important part of the formation process that often gets overlooked.

Step 6.  The initial directors adopt the corporation's initial written consent, whereby they, among other things, (i) elect the officers and (ii) authorize the issuance of stock to the founders.

Step 7.  The founders enter into Restricted Stock Purchase Agreements ("RSPA"s) with the company to purchase the shares at par value, the idea being that at the time of formation the value of the corporation equals to the par value of its shares.  The amounts that the founders have to pay for the shares are very small, less than $1,000 in total, but it is important to make sure the founders actually do give this money to the company and that money is deposited into the company's bank account and accounted for in the books.  The company then issues receipts for the money received from the founders.

Step 8.  If the founders' stock is subject to vesting, the founders must make Form 83(b) election with the IRS.  They only have 30 days to do so from the date of the RSPAs.  There are no extensions.  Failure to do so on time can result in very onerous tax consequences for the founders.

Step 9.  The founders enter into Technology Assignment Agreements with the company, dated as of the date of the RSPAs, transferring to the corporation all IP they have developed for the company prior to its formation.  This is also a very important step.

Step 10.  One final agreement.  At the same time as the RSPAs and the Technology Assignment Agreements, the founders sign Confidentiality and Invention Assignment Agreements that say that all IP that they develop on behalf of the company going forward belongs to the company.  There can be exceptions.  For example, all inventions that do not relate to the company's business, that have been developed not using the company's facilities or equipment during off work hours belong to the employees individually, and not to the company.  This is the case for all companies located in California (even if they are DE corporations), and this exception is widely used in other states as well.

Step 11.  Get the EIN.  This can be done by completing form SS-4 and/or obtaining the EIN online.

Step 12.  Open a bank account.

Step 13.  Qualify the company to do business in the home state (assuming it is actually not located in Delaware).

This in my view completes the incorporation process.  If you have any questions, let me know.

This article is not legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Filing Delaware Annual Report Made Easy

Once a year, all domestic Delaware corporations must file an annual report and pay Delaware franchise tax.  They have to do so before March 1.  Missed deadline will result in a $125 penalty plus 1.5% monthly interest rate on the amount due.  Of course, companies can pay their Delaware registered agent, attorney, or accountant to file.  However, the process is so simple and straightforward that any startup can handle this on their own.

Here is the process step-by-step:

1.  Go to the Delaware Division of Corporations website.

2.  You will need to know your entity number.  You can search for it by corporation's name.

3.  Once you are in, you will need to enter your corporation's EIN.

4.  You will need to confirm / enter information regarding the corporation's address, directors, and officers.

5.  Most importantly, you will need to correctly calculate the amount of tax.  There are two methods used to calculate the franchise tax: the Authorized Shares Method and the Assumed Par Value Capital Method.  You can choose the method that results in less tax.  The lowest you pay with the Authorized Shares Method is $175 (plus a $50 annual report filing fee).  The lowest you pay with the Assumed Par Value Capital Method is $350 (plus a $50 annual report filing fee).
The Authorized Shares Method:

- 5,000 shares or less: $175
- 5,001 to 10,000 shares: $250
- every 10,000 additional shares above 10,000: $75 for each 10,000.
- Maximum payment: $180,000.

The Assumed Par Value Capital Method:

It is based on the number of authorized and issued shares and the entity's total gross assets (as reported on the corporation's tax return - Form 1120, Schedule L).  The tax rate under this method is $350 per million or portion of a million.  For examples, see DE's page on how to calculate franchise taxes here.

The most useful page is the franchise tax calculator.  Using this online calculator provided by the DE Division of Corporation will allow you to try both methods and determine which one results in lesser tax.

For example, a startup has 10 million authorized shares, $0.0001 par value per share, out of which 7 million shares have been issued and outstanding.  The gross assets value is very low, $20,000.

Using the tax calculator, we see that the Authorized Shares Method results in a $75,175 franchise tax.  Oouch!

Using the Assumed Part Value Capital Method results in a $350 tax.  Much better.  So, the total amount to pay would be $400 because you have to add a $50 filing fee.

As you can see, the entire filing takes about 5-10 minutes.  Just don't miss the deadline:

March 1 - domestic corporations, including nonprofits ($25 annual report fee) and PBCs (PBCs pay according to one of the two methods discussed above)

June 1 - LLCs, LLPs, LPs, and GPs ($300 annual report fee)

June 30 - foreign corporations ($125 annual report fee).

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Separation / Confidentiality Agreements Gone Too Far

It is not a surprise that employees are routinely asked to sign confidentiality agreements at the beginning of their employment as well as separation agreements at the end.  The problem is that sometimes such agreements limit the employees' rights in a way that violates the law.

Here, I am talking about the Dodd-Frank Act and the SEC Rule 21F-17.  The Dodd-Frank Act granted financial incentives to whistleblowers (between 10% and 30% of the penalty that the SEC would collect if their information led to an SEC action).  Rule 21F-17, which became effective in August 2011, prohibits the companies to interfere with the employees reporting potential securities law violations.  It says: "(a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications."

NeuStar Inc., a public company, used a non-disparagement clause in its severance agreements that forbade former employees to engage in "any communication that disparages, denigrates, maligns or impugns" the company, including communications with accountants, reporters, investors, customers, and regulators.  A breach of this clause could result in the loss of severance benefits. From August 12, 2011 to approximately May 21, 2015, at least 246 employees signed agreements with such clause, and the SEC order indicates that at least one of them wanted to talk to the SEC but could not because of the agreement.  As a result of settlement, NeuStar amended its nondisparagement clause to exclude federal regulators and paid a penalty in the amount of $180,000.

This is not an isolated enforcement of this Rule.  Earlier in 2015, the SEC brought an enforcement action against KBR, Inc., a public company. KBR required employees who acted as witnesses in certain internal investigations to sign a confidentiality clause that threatened disciplinary actions if such persons discussed the investigations with outside parties without the prior approval of KBR's legal department.  These investigations included possible violations of securities laws.  The company settled with the SEC by agreeing to amend the offending clause and paying a $130,000 penalty.

Yet another enforcement action was brought against BlueLinx, an Atlanta-based building products distributor, in August 2016.  BlueLinx required all departing employees to waive their rights to whistleblower monetary awards should they file a charge or a complaint with the SEC or other federal agencies.   BlueLinx settled with the SEC by agreeing to amend the clause and paying a $265,000 penalty.

The SEC has just brought another enforcement action for violation of Rule 21F-17, this time against Blackrock, Inc., for a clause in its separation agreements that removed the right to claim whistleblower awards from departing employees who chose to become whistleblowers.  Blackrock actually voluntarily stopped using this clause in March 2016, but by then over 1,000 departing employees had already signed it.  BlackRock's penalty was $340,000.

The lesson is an obvious one here: companies should review their separation and confidentiality agreements to ensure they do not violate the employees' rights to file complaints with the SEC and receive financial rewards for doing so.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.