What Startups Should Know Before Moving to Another State

Startups may move states for several reasons. Sometimes the move is driven by simple things such as the founder planning to move or the engineering team going remote. Or maybe a major investor prefers another jurisdiction. Other times, the company may have outgrown the state where it was founded, or the legal home selected at formation doesn’t match the startup’s financing plans or operating footprint. 

When a startup decides to move, it is not simply a clerical project. An entire network around the startup is often affected and must be considered. Investor rights, equity awards, intellectual property, debt instruments, and tax positions must all be taken into account. 

Though the company may plan to move without interrupting business operations, a filing that changes the state of the organization can affect documents that were created in the original jurisdiction. 

The cap table is the first place to look

A capitalization table, commonly called a cap table, records the company’s ownership structure, including shares held by founders, investors, and employees. When the company decides on a legal process for moving its state of formation, all documentation related to ownership should agree on who owns what and what rights are outstanding. The stock ledger, SAFE instruments, board consents, convertible notes, warrants, option grants, and preferred-stock documents should all be consistent with the cap table.

The goal is generally for the company’s owners and investors to retain the same ownership rights and financial benefits after the company moves its legal home to another state. Before transferring a company to a new state, founders should decide how the move will affect owners and investors. If they decide to keep the existing ownership structure, the legal process should not change how ownership is divided. 

Though this seems like a straightforward process, it can become complicated when a startup has different types of stock or investors with special rights. The company may have to update its existing agreements and governing documents to comply with the new state’s laws. Rules established in one state may not apply in another. 

Investor consent can be a transaction requirement, not a courtesy

Before announcing a filing date, a startup may need permission from various groups of people before it can legally move to another state. Some investors or lenders might have to approve major business decisions. The board of directors may also need to approve the move before a shareholder vote occurs. 

Additionally, the startup’s charter, voting agreement, investors’ rights agreement, side letters, or debt documents may restrict a change in legal jurisdiction. Noteholders may have a notice or consent right if transferring to a new state fits under the definition of a reorganization or merger. Some preferred shareholders may also have the right to approve major changes to the company.

All these rights should be mapped out before the startup announces a filing date. If a business doesn’t get permission for the move until after it’s finished, it may breach an investor agreement. If the move doesn’t comply with the company’s existing documents, investors may not want to be involved in a new financing round with the startup. 

For these reasons, a startup should keep a record showing that every action required for the move happened in the intended order. 

Equity compensation deserves its own workstream

Many startups compensate employees with company shares, or the chance to acquire them. When the startup changes states, it should take steps to ensure employee stock-related benefits remain properly documented. The company may need to update employee stock compensation documents if they refer specifically to the startup’s original state of incorporation or its existing charter. All outstanding stock awards and agreements need to be reviewed to ensure they will be valid and accurate after the move. 

When transitioning a startup to a new legal jurisdiction, the original terms or history of employee stock awards don’t automatically change. Existing records should be preserved, including when awards were granted, any applicable purchase or exercise prices, and vesting schedules. Any changes made to the employee stock compensation agreement during the move may require a legal and tax review. 

Federal taxes require separate consideration

Moving a startup’s legal home to a different state doesn’t mean the change will be tax-free. Before the transition, the company should review its federal tax obligations to identify potential issues.

Federal tax requirements still apply even if a corporation retains its corporate structure and its existing Employer Identification Number (EIN). Tax consequences can also vary depending on whether the startup is an S corporation or a C corporation. 

IP and contracts should follow the entity, not a new shell

Intellectual property is often the most valuable asset of a startup. Before the move, a company should confirm that patents, trademarks, software rights, and other intellectual property belong to the company. If any are held personally by a founder, changing states may not fix ownership problems involving these assets. 

Major contracts should be reviewed to see if lenders, landlords, or business partners must approve or be notified of the move. 

Prepare for the new state’s laws

When a startup moves to another state, it has to comply with different corporate laws, which may affect shareholder rights, voting procedures, and protections for directors and officers. Governing documents should reflect all new requirements. Financial and operational records may also need to be updated, relevant business partners should be notified, and any registrations that are still required in the former state should be maintained. 

By carefully planning its jurisdictional move, a company may preserve its existing ownership arrangements and avoid complications during future financing rounds. By taking these precautions, startups can make the transition while protecting their business interests and preparing for future growth. 

The information provided in this article is for general informational and educational purposes only. It is not intended as legal, financial, medical, or professional advice. Readers should not rely solely on the content of this article and are encouraged to seek professional advice tailored to their specific circumstances. We disclaim any liability for any loss or damage arising directly or indirectly from the use of, or reliance on, the information presented.

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