Why Silicon Valley VCs Want You to Be a Delaware C-Corp
One topic that frequently comes up for Canadian founders raising from U.S. VCs is the location of their startup’s incorporation.
“Are you a Delaware C-Corp?”
What exactly is a Delaware C-Corp and why do Silicon Valley VCs care so much about where your company is incorporated?
What is a Delaware C-Corp?
Let’s start with the basics. A C Corporation (or C-Corp) is the most common corporate structure in the U.S. It’s a legal entity in which the owners (or shareholders) are taxed separately from the company itself. In Canada, the equivalent is a Canadian-Controlled Private Corporation (or CCPC).
In the U.S., just like in Canada, the choice of state/province in which you incorporate has both legal and tax implications. Delaware is the preferred state of incorporation for most businesses because the state has more than 200 years of business-friendly legal precedents. The high volume of corporate disputes that the Delaware Court of Chancery has processed has resulted in judicial outcomes that are overwhelmingly predictable. In addition, the court has a history of protecting the rights of founders and board members to make business decisions without risking personal liability.
Delaware does not require that a company be physically based there in order to incorporate in the state. You are only required to have a Registered Agent (a Delaware-based intermediary who receives and forwards legal documents and correspondence from the Delaware Division of Corporations to you).
When I was a founder, the companies that I raised VC capital for (or considered raising external capital for) were all Delaware C-Corps.
What About Companies Outside of the U.S.?
Right now, you might be thinking “all of this sounds great, but my company is based in Canada — who cares?”
In this case, it helps to think about things from the perspective of a (U.S.-based) investor.
If your company is incorporated in Delaware, then investors (and potential investors) don’t have to spend brainpower thinking about potential tax or legal implications resulting from where your company is domiciled. On the other hand, if your company is incorporated outside of the U.S., then there are real implications for them as investors. And these aren’t just theoretical:
The U.S. government is very serious about keeping track of foreign investments made by U.S.-based firms. When an American VC invests in a Canadian company, it’s very likely that they will have to file additional paperwork about that investment each-and-every year. So in addition to the potential legal risk (or, at least, uncertainty) they incur by investing in a Canadian-domiciled company, doing so all but ensures that they will be doing extra paperwork as a result every year.
And nobody likes paperwork (even VCs).
Beyond paperwork, it’s helpful to empathize with the degree of uncertainty that potential investors might feel about investing internationally.
As the saying goes, you don’t know what you don’t know. So while it’s easy to say that “great companies can be based anywhere,” a typical investor has likely never given much thought to the tax and legal implications of investing in startups based in other countries. Your average Silicon Valley VC has no clue how Canadian taxes or laws work. Nor do they have any particular inclination to learn.
That doesn’t mean that they don’t want to invest in your company (they wouldn’t be talking to you if that was the case).
What it means is that figuring out whether or not they can invest in an Ontario-, Quebec- or BC-domiciled company just may not be worth the effort to them if it’s unlikely that they’ll invest in another one anytime soon.
So while there are many Silicon Valley VCs that are comfortable investing into Canadian-domiciled companies, the majority still fall back to the simple position that “we only invest in Delaware C-Corps.”
What Are Your Options?
As a Canadian founder, there are many reasons to want your company to remain domiciled in Canada. Many grant programs are only available to CCPCs while others, like SR&D, have material differences depending on whether or not the company is domiciled in Canada. Plenty of Canadian founders simply want their company to be Canadian (and that’s awesome!).
So what are your options if you’re looking to raise from Silicon Valley VCs but want to remain a Canadian-domiciled company?
1. Know Your Numbers
As part of your preparation for fundraising, figure out the exact costs of losing your status as a CCPC. Would you see a reduction in SR&D credits? Would you lose access to other relevant grants or government-sponsored opportunities?
A number of companies I’ve invested in have responded to requests by Silicon Valley VCs to reincorporate as a Delaware C-Corp by calmly stating:
“We aren’t willing to do that because it would cost us $Xm/year in government grants.”
U.S. investors rarely think about grants and tax breaks as part of their investment decision, so coming prepared with meaningful numbers can be very impactful.
2. Know Your Emotions
If remaining a Canadian-domiciled company is important to you for non-financial reasons, that’s equally as significant. But you need to think in advance about how to convey that to potential investors.
Too many founders don’t think through how to explain their convictions and instead ramble unprepared and off-the-cuff about how it’s “important to them.”
Americans are some of the most patriotic people on earth, so they will often be very receptive to founders who express sincere conviction around this. But it can’t be ad libbed.
3. Know Your Line
Bottom line: is this a deal-breaker for you?
Understanding the answer to that simple question before you talk to VCs is incredibly important (and will likely influence whether or not you get the result you want). Are you willing to walk away from an investor to remain a CCPC or is this a position that you’re willing to give up for the “right” VC?
Because it may be a deal-breaker for them.
At the end of the day, you should expect the majority of U.S. VCs to ask you to reincorporate as a Delaware C-Corp. It’s not a red flag and it’s not something they’re doing for spurious reasons — investing in Delaware C-Corps is easier, cheaper and and more predictable for Silicon Valley VCs.
But if it’s important to you to remain a Canadian-domiciled company, then come prepared. Explaining with conviction (ideally backed up by numbers) why you intend to remain a CCPC is the most effective way to get the result you want.
