Setting up the company

Northwind Labs is two founders, Ada and Ben, and some code on a laptop. An investor cannot buy a part of a laptop. Before anyone can invest, Northwind must become a company that can issue shares. This lesson shows the setup that investors expect. It also shows a tax notice that frightens many founders, and the one step that makes it small.

Incorporation makes the company

To incorporate, you file a short document with a state: the certificate of incorporation. The state then records a new legal entity. This step is incorporation. The new company can sign contracts, own code and patents, hire employees, and get money from investors. The founders own the company because they hold its shares.

In Delaware, the state fee for a basic certificate of incorporation starts at $109, from the fee schedule of August 1, 2026. Faster service costs more: $50 for 24-hour service and $100 for same-day service.

Why a Delaware C corporation

Most startups that want venture money are a Delaware C corporation. The name holds three separate decisions. Each decision comes from what investors need.

A corporation, not an LLC

An LLC is a “pass-through” entity. Its profits and losses go onto the personal tax returns of its owners. Many investors in VC funds are tax-exempt, such as university endowments and foundations. Pass-through business income can cause tax problems for these investors. Thus the legal documents of many VC funds do not let the fund invest in an LLC.

You can convert an LLC into a corporation later. But the conversion costs legal fees and time, and it can cause tax problems. If you plan to raise venture money soon, start as a corporation.

A C corporation, not an S corporation

An S corporation is a corporation that selected a special tax status. IRS rules give it these limits:

• It can have a maximum of 100 shareholders.
• Only individuals, some trusts, and estates can own its shares. Partnerships, corporations, and non-resident aliens cannot.
• It can have only one class of stock.

Most VC funds are partnerships, so most VC funds cannot own shares in an S corporation. The one-class rule is also a problem. VC investors buy preferred stock, a second class of stock with more rights. A C corporation has none of these limits.

Delaware, not your home state

Investors and lawyers know Delaware law. They also know its business court, the Court of Chancery, and the standard financing documents. The law firm Cooley writes that these documents “have primarily been designed for Delaware corporations.” In its 2025 annual report, Delaware says that more than two-thirds of the Fortune 500 companies are Delaware corporations.

A C corporation also has a tax benefit. Its stock can be QSBS. The rules changed on July 4, 2025. For stock that a company issued after that date, a holder who keeps it for 5 years can exclude up to $15M of gain from federal tax. The limit is 10 times the price that the holder paid for the stock, if that number is larger.

Here is the effect on a $10M gain. Without QSBS, the top federal rate on a long-term gain is 20%, plus a 3.8% tax on investment income. With the full exclusion, the tax is $0:

Tax without QSBS = 23.8% × $10,000,000
                 = $2,380,000
Tax with QSBS    = $0

The lesson on QSBS gives the full rules. Speak to a tax professional before you depend on them.

When the founders are in a different place

A Delaware corporation with its office in a different state must usually register in that state too. This is foreign qualification. The company then pays the taxes of that state. California, for example, charges a minimum franchise tax of $800 each year. A new corporation does not pay this minimum in its first taxable year.

Founders outside the US face a different question. YC invests in “US, Canada, Cayman, and Singapore corporations.” A founder with a company in a different country, such as the UK or India, usually does a Delaware flip:

1. The founders make a new parent company in Delaware.
2. Each shareholder exchanges the local shares for the same percentage of shares in the new parent.
3. The original company becomes a subsidiary that the parent owns 100%. It continues to operate in its country.

The owners do not change. Two founders each own 50 of the 100 shares of a UK company. After the flip, they each get 4,000,000 of the 8,000,000 shares of the new Delaware parent. Each founder still owns 50%. A flip costs money and needs tax advice in the two countries.

What incorporation costs

Online services file the papers and set up the founder shares for you. These are the prices that the services showed in late 2026.

The first price is not the full cost. Each year, a Delaware corporation pays at least a $50 annual report fee and a franchise tax. For a typical early startup that calculates the tax correctly, this is $450 a year. The company also pays for a registered agent after the first year. The last section of this lesson shows the tax.

The company must own the code

Investors give money to a company because the company owns something of value: its code, its designs, and its inventions. If a founder or a previous employer owns that work, the company has a problem. Two documents prevent it:

• A technology assignment agreement. Each founder signs it at formation. It gives the company the work that the founder did before incorporation. Often this work is part of the payment for the founder shares.
• An inventions assignment agreement. Each founder and each employee signs one. Law firms call it a CIIAA or a PIIA. It keeps company information confidential, and it gives the company all future work.

Together, these documents are the IP assignment of the company. The exact words are important. Lawyers recommend present-tense words such as “hereby assign.” In a case that the US Supreme Court decided on June 6, 2011, a researcher signed a university agreement that said “agree to assign.” Later, he signed a company agreement that said “do hereby assign.” His rights went to the company, not to the university.

Here is the cost of a gap. A founder wrote 30,000 lines of code in the 6 months before incorporation and signed no assignment. At the Series A, the lawyers of the investors find the gap in due diligence. The round can stop until the founder signs. If the founder left on bad terms, the founder can ask for money to sign.

The first board

The board of directors controls the company. At formation, the incorporator adopts the bylaws, sets the number of directors, and elects the first directors. The board then appoints the officers, such as the CEO. It also authorizes the company to issue shares to the founders.

Michael Seibel of YC recommends that only the CEO holds a board seat before a significant equity round. A small board prevents a deadlock on hard decisions, such as the removal of a cofounder. SAFE investors usually do not get board seats. A priced seed round often adds one investor seat. CRV, a venture firm, says that most boards after a Series A have 3 to 5 members.

An odd number of seats prevents tie votes. On a board of 2 founders and 2 investors, a 2-to-2 vote is a deadlock. On a board of 2 founders and 1 investor, the founders win 2 to 1. The lesson on control terms shows how investors negotiate for seats.

The Delaware franchise tax trap

Each Delaware corporation files an annual report and pays a Delaware franchise tax by March 1 each year. The annual report fee is $50. This rule applies even if the company does no business in Delaware and has no revenue.

Delaware gives two methods to calculate the tax, and the company pays the lower result. The trap is that the default notice from Delaware uses the method that is worse for most startups.

Method 1: authorized shares

The authorized shares method uses only the number of authorized shares. These are the shares that the certificate of incorporation lets the company issue. The rates are these:

• 5,000 shares or fewer: $175.
• 5,001 to 10,000 shares: $250.
• More than 10,000 shares: $250, plus $85 for each 10,000 shares (or part of 10,000) more than 10,000.
• The maximum is $200,000.

Blocks = (10,000,000 − 10,000) ÷ 10,000
       = 999, rounded up
Tax    = $250 + $85 × 999
       = $85,165

Method 2: assumed par value capital

The assumed par value capital method uses the gross assets of the company and its issued shares. The calculation starts with the assumed par: gross assets ÷ issued shares. It then multiplies the authorized shares by the assumed par, or by the par value of the shares if that is larger. The tax is $400 for each $1M of that capital, rounded up to whole millions. The minimum is $400.

Northwind issued 8,000,000 shares: 4,000,000 to Ada and 4,000,000 to Ben. Its only asset is $50,000 of cash, so its gross assets are $50,000. Its par value is $0.00001 a share.

Move the inputs below. Start with the three examples, then change the authorized shares and the gross assets.

Method 1: authorized shares
Over 10,000 = 9,990,000 shares
Blocks      = 9,990,000 ÷ 10,000
            = 999
Tax         = $250 + $85 × 999
            = $85,165

Method 2: assumed par value capital
Assumed par = $50,000 ÷ 8,000,000
            = $0.00625
Capital     = 10,000,000 × $0.00625
            = $62,500
Tax         = $400, the minimum
            (capital under $1M)

The short form of the second method is capital = gross assets × authorized ÷ issued. Thus the tax grows when the assets grow. It also grows when the company leaves many authorized shares unissued. For this reason, Clerky tells companies not to leave a large percentage of their authorized shares unissued.

How to pay the lower amount

The Delaware website recalculates the tax when you give it two numbers. Do these steps before March 1:

1. Open the annual report on the website of the Delaware Division of Corporations.
2. Type the number of issued shares.
3. Type the gross assets from the federal tax return of the company.
4. Click “Recalculate Tax.”
5. Pay the new amount and the $50 fee.

If you file late, Delaware adds a $200 penalty. It also adds interest of 1.5% each month on the tax and the penalty.