Key Takeaways

  • California does not recognize corporate conversions to out-of-state entities; companies must merge into a new Delaware corporation instead.
  • Delaware offers legal and tax advantages, such as a specialized business court and flexible corporate statutes.
  • California C Corps still face California taxes even after converting to Delaware if they operate there.
  • Venture capitalists often prefer Delaware incorporation due to its predictability in corporate governance and investor protections.
  • Business considerations—such as cost, regulatory complexity, and operational footprint—should inform the decision to convert or incorporate.
  • UpCounsel can connect you with experienced attorneys to help navigate the process.

Conversion of California corporation to Delaware corporation is a step that California companies often want to take to satisfy the request of a venture capitalist (VC). They make this request because Delaware has a reputation as a “business-friendly” state and provides appealing tax incentives for investors.

In most cases, a conversion transaction is a relatively quick and easy way for a C corporation to reorganize in a new state. However, for it to happen, both states must accept the process, and, unfortunately for many California businesses, California is one of a handful of states that does not recognize the concept. The state will not allow a domestic corporation to convert into what it deems to be a “foreign” corporation.

Converting a Foreign Corporation to Domestic Corporation

When confronted with a situation where the state it is incorporated in does not allow a corporate conversion to another state, the remedy most C corporations take is to merge the existing business into a new C corporation. To accomplish this, the corporation:

  • Creates a completely new corporation in the state where it wanted the existing corporation converted to. In this case, a new corporation is incorporated in the state of Delaware.
  • Merges the existing corporation, which in this case is incorporated in California, into the Delaware corporation.
  • Causes the California business to no longer exist as it is survived by the Delaware corporation.

Here are the specific steps the California corporation would take:

  • Draft an Agreement and Plan of Merger and Incorporation.
  • Bring the agreement first to the board of directors, and then to the shareholders of the corporation for a vote.
  • Receive board consent to the agreement.
  • Receive shareholder consent to the agreement.
  • File a Certificate of Merger with the Secretary of State of California’s office.

In Delaware, the corporation would take these steps:

  • File Articles of Incorporation with the office of the Delaware Secretary of State.
  • Adopt bylaws and appoint a board of directors.
  • Issue stock in the Delaware corporation to shareholders.
  • Draft an Agreement and Plan of Merger and Incorporation.
  • Bring the agreement first to the board of directors, and then to the shareholders of the corporation for a vote.
  • Receive board consent to the Agreement.
  • Receive shareholder consent to the agreement.
  • File a Certificate of Merger with the Secretary of State of Delaware’s office.

While it may appear from the above example that it is a very easy process to circumvent California’s refusal to recognize a conversion of one of its domestic corporations into a foreign corporation, that is hardly the case. It is strongly suggested that a corporation desiring to do so consult a corporate attorney with experience in conversions, reverse mergers, transfers of assets, or other forms of corporate reorganization.

The easiest part of the process is incorporating a business in Delaware. This is because the corporation is entirely new, with no existing stock issues, complex business arrangements, contracts with vendors, or any other legal issues that could complicate the C corporation’s incorporation. The Delaware Secretary of State has a webpage that provides information and forms for converting an existing entity.

It is the process of merging an existing corporation from another state into this Delaware corporation where complications could arise. Therefore, it is vital to understand the factors that may come into play when seeking to transfer the assets of the existing corporation to another before moving forward. For instance:

  • What exactly are California’s rules around conversion?
  • What degree of board approval is required to transfer the assets? Must it be a unanimous vote, or is majority consent simply required?
  • What documentation is required by both states?
  • Are there any existing agreements or contracts that must receive separate consent from a third party?
  • How will the transfer affect the company’s stock, and what will the tax implications be?

As you can see, moving the assets of a California corporation into a Delaware corporation can be a very involved process. Due to California’s refusal to allow corporate conversion, it is not merely a matter of visiting a website and downloading forms as might be the case when converting a corporation from another state into Delaware. It is an issue the board of directors should look at from all sides.

Key Differences Between Incorporating in Delaware vs. California

When deciding between keeping your C corporation in California or converting it to Delaware, it's crucial to understand the key differences between these two jurisdictions. The phrase “C Corp Delaware vs California” commonly arises when evaluating these distinctions:

1. Corporate Law Environment

  • Delaware: Known for its Delaware Court of Chancery, a business-focused court with judges experienced in corporate law. This court enables faster resolutions and more predictable outcomes, especially in disputes involving fiduciary duty or shareholder rights.
  • California: Litigation proceeds through standard state courts, which may have less specialization in corporate matters.

2. Statutory Flexibility

  • Delaware: Offers highly flexible corporate statutes, such as the ability to waive certain fiduciary duties in LLCs and broad discretion in structuring boards and shareholder agreements.
  • California: Corporate law is more rigid and mandates stronger shareholder protections, such as cumulative voting in director elections and stricter rules on indemnification.

3. Privacy

  • Delaware: Requires minimal disclosure of shareholders or officers in public filings, offering a higher degree of privacy.
  • California: Requires more transparency, including listing officers and directors in public documents.

4. Filing and Franchise Taxes

  • Delaware: Franchise tax is based on authorized shares or assumed par value capital, which can be high for large companies but modest for smaller ones.
  • California: Franchise tax is based on income or a flat fee, and all entities “doing business” in California must pay it—regardless of where they’re incorporated.

5. Investor PreferenceVenture capitalists and institutional investors tend to prefer Delaware corporations due to the familiarity and predictability of Delaware law and its established legal precedents.

Ongoing Compliance Obligations After Conversion

Even after converting from a California C Corp to a Delaware entity, businesses may still face ongoing California regulatory burdens if they continue operating within the state.

Ongoing requirements include:

  • California Franchise Tax: Companies conducting business in California must file and pay the annual franchise tax, even if incorporated in Delaware.
  • Statement of Information: Foreign corporations doing business in California must file a Statement of Information annually with the California Secretary of State.
  • Registered Agent: Both Delaware and California require corporations to maintain a registered agent for service of process in their respective jurisdictions.
  • Local Licenses and Permits: Regardless of incorporation state, operating in California will require local business licenses and compliance with California labor and employment laws.

Understanding these post-conversion compliance responsibilities is essential for accurate budgeting and legal compliance.

Strategic Considerations for Venture-Backed Startups

Many California-based startups convert to Delaware corporations in anticipation of raising venture capital. This strategy is driven by:

  • Investor Expectations: Most VCs insist on investing in Delaware C Corps due to the legal protections and governance structures they are accustomed to.
  • Standardized Documentation: Delaware has standardized, investor-friendly corporate forms that streamline the due diligence process.
  • IPO Readiness: For companies planning to go public, Delaware’s corporate governance framework aligns well with federal securities law and is widely accepted by underwriters and institutional investors.

While Delaware is often the default choice for high-growth startups, the administrative and tax burdens of dual-state compliance should still be carefully considered.

Tax Implications of Converting from California to Delaware

The tax consequences of conversion are significant and often misunderstood. A Delaware corporation doing business in California will still owe California corporate income tax and minimum franchise tax (currently $800 annually, though subject to legislative changes).

Key tax implications include:

  • Double Filing: Corporations may need to file tax returns in both Delaware and California.
  • Apportionment Rules: Income earned in California is taxed by California, even if the business is incorporated elsewhere.
  • Asset Transfers: The merger or asset transfer required for conversion may trigger taxable events, depending on the structure.

Proper tax planning with legal and accounting advisors is essential when undertaking this transition.

Alternatives to Conversion

If converting your California C Corp to a Delaware C Corp proves too complex or costly, alternatives may include:

  • Dual Qualification: Keep the California entity and register it to do business in Delaware, or vice versa.
  • Asset Sale: Sell the assets of the California corporation to a newly formed Delaware corporation.
  • Form a Parent Holding Company in Delaware: Create a Delaware holding company and make the California C Corp its subsidiary.

Each option comes with legal and tax implications, and the best choice will depend on the company’s goals and existing structure.

Frequently Asked Questions

  1. Can I simply convert my California C Corp to Delaware without merging?
    No. California does not recognize outbound conversions. You must use a merger or asset transfer.
  2. Will I still need to pay California taxes after converting to Delaware?
    Yes. If your business operates in California, you will still be subject to California tax obligations.
  3. Why do investors prefer Delaware over California?
    Delaware’s legal system, flexible statutes, and privacy protections make it more attractive to investors.
  4. What is the cheapest way to incorporate in Delaware?
    Using Delaware’s assumed par value method can help lower franchise tax costs for startups.
  5. Do I need a lawyer to convert my corporation?
    Given the complexity of corporate reorganizations, it is strongly recommended to consult a qualified corporate attorney. You can find one on UpCounsel’s marketplace.

To learn more about a conversion of a California corporation to a Delaware corporation, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.