The Importance of State-Level Compliance for Startups
State-level compliance is essential for startups to operate legally and avoid penalties. Recent cases involving Carta and Pulley highlight the challenges that startups face in maintaining compliance with state regulations.
In 2022, Carta had its business license revoked in Illinois for failing to pay franchise tax, while Pulley faced a similar situation in Washington state in 2024. Both companies have since taken steps to rectify the issues and get their licenses reinstated.
According to Andrea Schulz, a lawyer at Grant Thorton, startups often overlook state-level compliance due to the complex fees, taxes, and registration requirements of each state. Failure to comply can result in fines and other consequences, which may only come to light during an acquisition, IPO, or audit.
Ginger Mutoza, a legal operations manager at 8×8, shared a similar experience of discovering compliance issues post-acquisition. She emphasized the importance of addressing these issues promptly to avoid costly repercussions.
The Challenges of State-Level Compliance
The main challenge startups face with state-level compliance is the lack of uniformity across states. Each state has different requirements and processes, making it difficult for startups to stay in good standing.
Robert Holdheim, COO of Traact, highlighted the inefficiencies of state compliance processes, with many states still relying on paper filings and checks. Illinois, in particular, is known for its cumbersome compliance procedures.
Furthermore, the rules for when a startup needs to register in a state vary, adding to the complexity of compliance. Failure to register can have legal implications and impact a startup’s ability to defend itself in court.
The Consequences of Non-Compliance
While the consequences of non-compliance are typically manageable, they can escalate if left unaddressed. Startups may face back taxes, fines, and legal vulnerabilities if they fail to comply with state regulations.
Acquirers may also be deterred by a startup’s compliance issues, potentially leading them to walk away from a deal. Additionally, startups may lose legal protections in states where they are not in good standing, putting them at risk in legal disputes.
To mitigate these risks, startups should prioritize state-level compliance early on and invest in compliance software or legal expertise. Companies like Traact, Mosey, DFIN, and Vanta offer services to help startups navigate state regulations and stay compliant.
Overall, founders need to incorporate state-level compliance into their business plans from the outset to avoid penalties and legal complications down the line.
