I just met a few folks who incorporated their startups in Delaware. Because their attorneys told them that was the best place to do so; given their goal to raise venture capital.
I admit that Delaware is a great state for C corporations; but Nevada and Virginia are good alternative domiciles. Given this new interpretation of Delaware laws that we will discuss today, they may become even better than ever.
Delaware’s corporate law has a section (220) that can be used to require local firms (as opposed to foreign registration entities) to open up their books for shareholders to view. And, you say, so what?
Well, many high tech firms provide stock to their new employees, the ones helping them grow the business with the founders. And, those small investors who helped you get started (to become big enough to get the big venture capital) are also included in this interpretation of the law.
These stockholders need to have just 1 (yes, ONE) share of stock in the firm. And, they then allege in an affidavit which corporate documents they wish to see and why- “for the purpose of valuing my shares”. Those seven words are the keys to the magic kingdom.
Oh, and those documents you demanded employees sign, the ones that stated they “waive their rights to inspect the books” as a condition to receiving stock. Fuhgeddaboudit.
Because, now, the Delaware incorporated entity has to comply. It can try to fight the request- but that means hiring an attorney to defend it in court for the failure to do so, with a very remote chance of prevailing.
The company can demand the shareholder sign a non-disclosure document. Yes, they will see the financial information they need, but won’t be able to share it with anyone. Because it probably still is critical, until the company goes public, to keep this corporate data out of the full public view. The company’s growth plans, its competitive advantage relies on keeping this data confidential.
As I have repeatedly stated, these were among the reasons why we never provided our employees anything but virtual stock. That virtual stock still afforded them dividends, still afforded them the right to see the data our board felt could be shared. But, only when we sold the company (and in one case took the company public) did that virtual stock convert to true certificate stocks.
Moreover, the SEC (Securities and Exchange Commission) feels alarmed that there are so many private companies that seem to be worth at least $ 1 billion. How many? At least 145 Delaware entities. The SEC has decided that these firms are among the targets for additional regulation, along the lines of Section 220- and more.
