Why Delaware?

There's a myth that Delaware law is popular because it favors management over shareholders (or preferred shareholders over common).  That's simply not true.  There are four basic reasons sophisticated shareholders (e.g. VCs, but also founders) and experienced managers prefer Delaware law:

First, it's predictable.  California is a big state, but it still doesn't close to the volume of litigation on corporate law issues that Delaware does.  No state comes close.  A lot of litigation means that you can find definite answers in the Delaware case law to questions that are simply undecided in other states.  Delaware also has a Chancery Court that is largely dedicated to corporate litigation, does not conduct jury trials and is staffed with judges chosen in a relatively non-political process for their expertise in corporate law, not their political contributions.  Appeals from the Chancery Court go directly to the Delaware Supreme Court whose members, though less specialized, spend a large percentage of their time on corporate questions.

Second, it's efficient.  Delaware relies on the incorporation business for a large percentage of its state budget.  Accordingly, the secretary of state's office is well staffed and customer oriented.  I've had nightmares closing deals in which I needed to get “good standing” certificates from other jurisdictions.  There's never any worry about Delaware.  They’ll charge you if you need same day service, but they’ll provide it.  What's true of the secretary of state's office is also true of the courts: They're expert and efficient.  If the circumstances warrant it, you can get from complaint to supreme court decision in a few months.  No other state comes near to that.

Third, it's neutral.  Delaware law means that no one is going to get a hometown advantage over other parties.  A few years ago a rival tried to make a hostile bid for the Taubman shopping center REIT, taking advantage of a loophole in Michigan's harsh anti-takeover law (something, incidentally, you won't find in Delaware because it isn't interested in “protecting” local companies).  The Taubmans were able to get the Michigan legislature to “fix” the law before the bid could proceed.  That kind of monkey business would never happen in Delaware.  Delaware's legislature understands that the value of its incorporation franchise is far more important than the interests of any individual or company, no matter how big, local and generous with political donations.  Changes to the corporations code are made cautiously at the suggestion of a panel of non-political experts.  Judges are non-political.

Finally, and most importantly, Delaware law is flexible.  There are almost no mandatory rules telling you how to set up your governance structure.  That's good for sophisticated parties who want to negotiate a deal and know that it will be enforced.  Of course, it means that you should know what you're doing if you're negotiating the complex set of governance arrangements typical of a venture capital financing.  Delaware law contains few mandatory provisions designed to protect clueless stockholders.  If you negotiate for governance rights of almost any kind and properly document them, you’re almost certain to get them.  If you don’t, you probably won’t.  Delaware law is designed for well-advised stockholders who want the freedom to write their own ticket.  In the final analysis, however, the Delaware courts deal harshly with people (e.g. controlling stockholders) who truly abuse their power to rip off minority shareholders, as opposed to exercising the rights for which they negotiated in the first place.

It is true that California (and other states) have laws that sometimes give shareholders mandatory rights that they didn’t bargain for.  But bear in mind that your investors are shareholders, too, so it cuts both ways.  As a rule, it’s not wise to rely on mandatory provisions to swoop in and save you.  It’s far better to negotiate for what you think you need, get what you can, and make sure your deal is properly documented.