It used to be a no-brainer: start a company, incorporate in Delaware. That is no longer the case due to recent actions by the Court of Chancery, which have injected an unprecedented level of subjectivity into judicial decisions, undermining the court’s reputation for unbiased expertise. This has introduced legal uncertainty into what was widely considered the gold standard of U.S. corporate law. In contrast, Nevada has taken significant steps in establishing a technical, non-ideological forum for resolving business disputes. We have therefore decided to move the state of incorporation of our primary business, AH Capital Management, from Delaware to Nevada, which has historically been a business friendly state with fair and balanced regulatory policies.
We could have made this move quietly, but we think it’s important for our stakeholders, and for the broader tech and VC communities, to understand why we’ve reached this decision. For founders considering a similar move, there is often a reluctance to leave Delaware, based in part on concerns for how investors will react. As the largest VC firm in the country, we hope that our decision signals to our portfolio companies, as well as to prospective portfolio companies, that such concerns may be overblown. While we will continue to fund companies incorporated in Delaware, we believe Nevada is a viable alternative and may make sense for many founders.
The foundation of Delaware’s historical reputation has been non-ideological, specialized business courts that have developed a robust body of case law around the so-called “business judgment rule”, legal shorthand for a (rebuttable) presumption borrowed from English common law that boards of directors act in good faith and with informed judgment when making business decisions. Over the years, the Delaware courts developed a limited number of objective, common sense exceptions to this general rule; however, recently, those exceptions have begun to swallow the rule. Director independence has been questioned in cases where the board has granted “moonshot” grants to exceptional founders, and in one notable case the court reprised the chorus from Hotel California by rejecting a board’s decision to move its place of incorporation out of Delaware (although it was later reversed by the Delaware Supreme Court). This has rightly caused tech startup founders to question the primacy of Delaware.
Although the Delaware Legislature has taken some exception to these developments, its actions fail to take full measure of the problem. In particular, Delaware courts can at times appear biased against technology startup founders and their boards. Litigation – even where successfully defeated – is costly and time consuming, particularly for the tech startups that need every penny they raise to build innovative companies. The resulting legal uncertainty is a real cause for concern for entrepreneurs and their professional investors who often sit on their boards. As a result, many of the companies we fund and the entrepreneurs that we talk to are taking a second look at whether they should incorporate in other jurisdictions, prompted by the departure from Delaware of significant technology companies like Dropbox, Tripadvisor and Tesla.
Nevada has taken a different path, choosing instead to codify the business judgement rule in statute, eliminating the ability of judges to modify or change the rule. In addition, the Nevada legislature recently passed two measures that take significant steps toward upgrading its existing business courts into specialized venues to resolve complex commercial disputes. AB 239 provides for a waiver of jury trials in civil cases, while AJR 8 calls for the adoption of a constitutional amendment to permit the direct appointment of business court judges by the Governor, rather than through the current system of elections. Both measures passed with overwhelming bipartisan majorities in the state Assembly and Senate, receiving the support of Nevada’s Republican Governor and Democratic Secretary of State, Speaker of the Assembly, and Senate Majority leader. While more work remains to be done on reforming Nevada’s business courts, we think that these measures represent a critical step in making Nevada a destination of choice for entrepreneurs.
A more detailed summary of the reasons for our decision to move from Delaware to Nevada is provided below.
Statutory Business Judgement Rule. The presumption of good faith and informed decision making is the bedrock of any corporate code that seeks to encourage entrepreneurship and risk taking. While Delaware was a pioneer in this area of law, what developed was a creature of judicial decision, not statute. The critical limitation of this approach has been made plain in recent years – what judges have given, they can take away. By codifying the business judgment rule in statute, Nevada has significantly limited this risk. A statutory business judgement rule limits judicial modification of the presumption, as demonstrated by the Nevada Supreme Court’s definitive ruling that this statutory standard exclusively governs director and officer liability, rather than subjective doctrines such as “entire fairness” (which Delaware courts have employed to weaken the presumption). While Delaware has recently enacted a safe harbor that provides more certainty in applying the business judgment rule, it does not cover non-public companies such as tech startups, and the rule itself remains a judicially created one that can be modified. Nevada’s categorical approach also distinguishes it from other jurisdictions like Texas, which have also codified the business judgment rule in statute, but have retained judicially created doctrines such as “entire fairness” which can be used to circumvent it.
Shareholder Limits on Director and Officer Exposure. Nevada law, by default, permits broad protections against individual liability for officers and directors. Monetary damages are excluded if they result from any act or failure to act in a person’s capacity as an officer or director unless a plaintiff (i) rebuts a presumption that the officer or director acted in a good faith and informed manner and (ii) proves that the act or failure to act is a breach of a fiduciary duty involving intentional misconduct, fraud or a knowing violation of law. Given the legal risks that exist for directors of large and emerging companies alike, strong statutory protections are critical to ensuring our portfolio companies can attract the highest caliber directors. While Delaware also permits companies to limit damages of officers and directors, any limitations are subject to judicial doctrines. This is particularly troublesome where Delaware courts appear to show bias against founders and their boards, and are applying increasingly large damages against defendants. In light of these concerns, General Partners in our firm are reconsidering whether they should serve on the boards of Delaware companies. Other jurisdictions, like Texas, which are potential alternatives have similar rules as Delaware and therefore pose similar risks.
Inspection of corporate books and records. Nevada provides only 15% or greater stockholders the right to inspect “books and records”, which significantly limits the ability for plaintiff lawyers to engage in fishing expeditions and bring frivolous lawsuits. In contrast, Delaware permits any stockholder of record to inspect a company’s “books and records” for any “proper” purpose related to a stockholder’s interest if such request is brought in good faith. The Delaware legislature recently amended the law to limit “books and records” inspections to certain explicit categories of materials and these rights are, in some cases, time limited; however, these limitations do not overcome the advantages of the bright line rule adopted by Nevada.
Established Business Courts. The greatest advantage enjoyed by Delaware is the specialized expertise of the Court of Chancery. However, that advantage has eroded as judicial decision-making has increasingly seemed to veer away from the technical expertise for which it is known. Nevada has taken steps to narrow the gap. Currently, Nevada has a business court. All judges are elected in non-partisan elections to 6 year terms, and those who are designated to serve on the business courts are selected by the Chief Judge to ensure the requisite business background and judicial experience. By amending state law to permit the waiver of jury trials, Nevada has taken a significant step to ensure that business court judges, rather than uninformed lay juries, can resolve complex commercial disputes. The proposed constitutional amendment process initiated earlier this year would cement this development by allowing the Governor to appoint judges with the requisite legal and business experience to preside over these cases, as they do in Delaware. While more work remains to be done, we are encouraged by these concrete developments.
Nothing in this post should be taken as legal advice. Founders and their boards must consider their particular facts and circumstances, and consult with competent counsel in making their decisions about where to incorporate. But we hope that by transparently explaining why we chose Nevada, it will be easier for founders of tech startups to have these conversations with their boards.
