The Delaware Franchise Tax: Don’t Freak Out

Within the next few weeks, corporations incorporated under the law of Delaware will receive ominous notices from their registered agents or the Delaware Divisions of Corporations advising such corporations of their annual obligation pay the their Delaware Franchise Tax.

Save for “83(b) elections,” “scalability” and “valuation”, no other concept strikes fear into the hearts of first-time founders more effectively than their first Delaware Franchise Tax notice.

The good news is that the calculations you may have run that indicate you owe tens of thousands in franchise taxes are wrong.  The bad news is, you still probably have to pay at least $400.

Repeat after me: “The Assumed Par Value Capital Method.”  With inputs of gross assets (consult your accountant) below $1,000,000, issued shares of 8,000,000 and authorized shares of 10,000,000, you’d only owe an absolute minimum of $350 (plus the $50 filing fee for a total of $400).

You and your lawyers may have spoken about a buffer between your issued and authorized shares.  In the above example, there’s a 20% buffer for an Equity Incentive Plan.  Sometimes, the buffer is greater than 20%.  Then, your Franchise Tax will be greater than $350, but not by much.

Why would any attorney in their right mind create a buffer large enough to increase your franchise tax?  Well, it costs nearly $600 in filing fees (not counting legal costs) to amend your charter to increase the amount of authorized shares.  So a larger buffer is occasionally created when there’s a possibility of (a) an additional founder coming on-board or (b) an early strategic partner that wants to pay for and own 5-10% of your Company’s common stock.

Separately, for those of you raising your initial funds via convertible notes, SAFEs, or similar instruments, Delaware law requires that you have enough authorized common stock to issue to your purchasers of such convertible securities should such purchasers convert their interests into common stock pursuant to standard (but infrequently invoked) mechanics in those convertible instruments.

How to Prepare for an Equity Financing

We have covered in past FTTWs how to value your startup and how much capital to raise. Once your startup decides to pursue equity financing, you should start to prepare for the investor due diligence process. On the business side, you will need to prepare a business plan and should take steps such as obtaining management references, interviews and background reviews, customer/user references, technical/product reviews, financial statements and business model reviews.

What Every Startup Needs to Know

On Wednesday, June 26th, Perkins Coie’s Palo Alto office hosted the startupPerColator event, “What Every Startup Needs to Know.” Lowell Ness, a Perkins Coie partner in the Emerging Companies & Venture Capital (ECVC) practice, moderated a panel which included Herb Stephens of NueHealth, Thomas Huot of VantagePoint Capital, Jennifer Jones of Jennifer Jones and Partners, Yuri Rabinovich of Start-up Monthly, and Olga Rodstein of Shutterfly.