Prof. Jesse Fried of Harvard Law School co-wrote an article that explains why Delaware corporate law is preferred by start-ups backed by venture capitalists. A summary of the article begins as follows:
Delaware dominates the corporate chartering market in the U.S—it is the only state that attracts a significant number of out-of-state incorporations. As a result, incorporation decisions are “bimodal,” with public and private firms typically choosing between home-state and Delaware incorporation.
Much ink has been spilled in the debate over whether Delaware’s dominance arose because it offers high-quality or low-quality corporate law. Under the “race-to-the-top” view, Delaware has prevailed because its law maximizes firm value. Under the “race-to-the-bottom” view, Delaware has won by offering corporate law that favors insiders at other parties’ expense.
But a firm today may choose Delaware law not solely because of its inherent features but rather because, after decades of Delaware’s dominance, business parties—including investors and their lawyers—are now simply more familiar with Delaware law than the laws of other states. Indeed, the bimodal pattern of domiciling is itself strong evidence that business parties are familiar only with their home states’ corporate law and Delaware’s.
In our paper, Delaware Law as Lingua Franca: Evidence from VC-Backed Startups, recently made public on SSRN, Brian Broughman, Darian Ibrahim, and I show, for the first time, that familiarity does in fact affect firms’ decisions to domicile in Delaware rather in their home states.
We predict that, if the typical business party is “bilingual” in Delaware law and the law of its own home state, and familiarity with corporate law matters, a firm will be more likely to incorporate in Delaware rather than in its home state if the firm receives financing from out-of-state investors. In other words, Delaware law can be expected to serve as a “lingua franca”: firms seeking out-of-state investors will be more likely to use Delaware law so they can provide a common language to all of their investors.