When do I “really” need to qualify my Delaware-formed startup in Texas?

So you’ve formed your Texas-based startup in Delaware.  You’ve paid your filing fees, filed your 83(b)s, and, if applicable, paid your lawyer. What’s left? Qualifying as a “foreign” entity to do business in Texas. Think of it as Texas’ way to punish you, via a $750 fee, for not incorporating in the mother land. It’s also the mechanism by which Texas can begin to bill you annually for state franchise taxes.

Link to Qualification Form

Do I really need to pay this?

While the gut reaction of most lawyers is to just make you pay the fee at formation, $750 is a pretty sizable amount of money relative to a formation’s total cost. So the inevitable question is, can I hold off on paying it? Maybe. Registration must occur within 90 days of “transacting business” in Texas under the Texas Business Organizations Code. But what exactly is “transacting business?”

Under TBOC 9.251, these are some activities (the list is non-exclusive) that do not constitute “transacting business,” and hence don’t require registration (shortened for relevance):

  • Holding a meeting of officers or shareholders re: internal affairs of the Company;
  • Maintaining a bank account;
  • Effecting sales through an independent contractor;
  • Transacting business in interstate commerce;
  • Conducting an isolated transaction that’s (i) complete within 30 days, and (ii) not part of a longer series of transactions;
  • Owning real or personal property.

A general rule of thumb is that it’s time to qualify when you have employees in Texas, apart from founders.

What happens if I don’t pay?

Failing to register in Texas at the right time leads to the following:

  • Inability to maintain an action/suit in Texas court;
  • Possible injunction from the state of Texas;
  • Civil penalty equal to fees and state taxes that would’ve been imposed if you’d registered at right time;
  • Late filing fees equal to (i) number of whole and partial calendar years unregistered, multiplied by (ii) $750.

Summary

A. Issuing shares, having a bank account, performing internal corporate activities, selling through independent contractors, and doing one-off short transactions do not require you to qualify in Texas. Doesn’t this sound like a lot of pre-seed startups with one or two founders (no full-time paid employees) coding away on their MVP?

B. If you ever need to maintain/defend a suit in Texas courts, or if for some crazy reason the State of Texas decides to file an injunction, you can just register at that time, and

C. If it turns out you register too late, the penalty is $750 for each year you were unregistered, and any taxes you would’ve had to pay anyway.

I’m not going to make any recommendations here, but I think a lot of founders might read between the lines and choose to delay that $750 check to the State of Texas until either (i) funding is on the horizon, (ii) they’re actually doing deals instead of just building a product, or (iii) it’s otherwise more clear that they’re “transacting business” in Texas.

2 Comments When do I “really” need to qualify my Delaware-formed startup in Texas?

  1. Brian Lee

    Jose,

    I stumbled across your wonderful blog and I cannot emphasize more how informative your site has been. Please keep it up for those in trenches :)

    After reading several of your posts, I was wondering whether I need a DE barred attorney to incorporate in DE. Again, your insight will be so helpful. Thanks!

    Reply

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