Startups are getting fined, or sometimes banned, by individual states

In 2022, Carta’s business license was revoked in Illinois for failing to pay franchise tax, a tax on national corporations doing business in the state, according to state records seen by TechCrunch. In 2024, Washington state terminated cap table software Pulley’s business license, according to state filings.

Carta spokesperson Amanda Taggart told TechCrunch that the company just missed the proper timeline to file its yearly report and pay the corresponding tax. Taggart added that the company has remedied the situation and is waiting on Illinois to return it to good standing. Yin Wu, the founder and CEO of Pulley, said that the company has filed the outstanding returns and is in the process of getting its license reinstated.

Startups like Carta and Pulley are definitely not alone in running afoul of state business rules. Plus, while these companies both had registered in these states as required and ran into issues later, many startups don’t begin the registration process in each state when they should at all.

When startups have employees in a state, conduct an acquisition or sign up customers there, they typically need to register in the state and maintain themselves in good standing. That includes paying their state taxes and fees on an ongoing basis, Andrea Schulz, a lawyer at Grant Thorton, told TechCrunch. If they don’t, they risk being fined by the state, or other consequences.

The problem, experts say, is that each state has its own complex fees, tax, and business registration requirements. And state-level compliance isn’t something top-of-mind for startup founders, nor is it a priority for an early-stage founder’s precious budget dollars, Schulz said.

“In some cases every dollar is going to the customer-facing solution,” Schulz said. “That is really why it ultimately happens. It’s not that it is too onerous, or a lack of expertise in that area.”

Schulz says that, when founders do misstep on state rules and fees, the fines or other issues may not come to light until a startup is being acquired, thinking of going public, or going through an audit.

Ginger Mutoza, a paralegal and corporate legal operations manager at contact center software company 8×8, told TechCrunch that she’s seen that first hand. She said her company is currently working to clean up the compliance of a company it acquired, issues which came to light after the due diligence process.

“They took the easy way out. They didn’t report any other mergers or stock option issuance to employees. We have to go back past the statue of limitations for tax claims,” Mutoza said. “We have to recreate history with a company. It becomes very expensive fixing those errors. They can just compound year over year over year.”

The challenge

The main reason state-level compliance is so hard for startups is that the states don’t make it easy. Each state wants different information in different formats to keep companies in good standing.

Robert Holdheim, the COO of back office and compliance platform Traact, told TechCrunch the company has yet to have a customer come to its platform that had all of its state compliance properly accounted for — even if they thought they did.

“I have the same attitude that everyone else does: it is a pain in the ass,” Holdheim said. “This is one of the areas that has always been left up to the states. They all do something completely different. There is no ability to easily access information. There’s very little digital information. You have to call in and wait for hours and hours.”

Illinois, that state that booted Carta, is particularly known for being difficult. For example, Illinois still only takes paper filings and payments by check.

The rules vary on when a startup needs to register, too. In terms of customers, some states require registration when a company is doing a vaguely worded “substantial amount” of business in a state, Mutoza said.

Most states do require registration when employees are located there, says Bruno Drummond, founder and partner at CPA and consulting firm Drummond Advisors. If a company tells their employees they can work from wherever, they are setting themselves up to have to file a foreign business entity every time someone moves to a new state. Many don’t keep up.

Consequences

The good news for most startups is that the consequences of getting state rules wrong are typically relatively mild. Companies pay the back taxes and the fines and get back into good standing.

However, the consequences could be more severe. If a startup’s state fines and issues are too onerous, this could be a catalyst for an acquirer to walk away, if it doesn’t want to pay to clean up the mess, Schulz said.

Not being a legal business entity in a state may also impact a startup’s legal protections in that state.

“If you are not in good standing in a certain state as an entity, officially every legal protection that entity has is suspended,” Holdheim said, pointing to Texas specifically. “If somebody sues you in Texas and your Texas entity is not in good standing, you automatically lose. You can’t appear in court if you don’t have legal protections in that state.”

He’s referring to Section 9.051 of the Texas Business Organizations Code, which prevents unregistered businesses from defending themselves against lawsuits in state courts. The same may go for initiating lawsuits in a state if the startup isn’t in good standing – like suing another business for using the startup’s proprietary intellectual property.

Drummond said that startups may also be dropping the ball in other areas like sales tax. He added that companies that have more than $50 million in investment or revenue need to file a monthly report with the U.S. Bureau of Economic Analysis, but most don’t. Hiring folks outside of the U.S. further complicates compliance too.

The upshot is that state-level regulations need to be factored into a founder’s business plans as soon as feasible, be it through investing in compliance software or through hiring legal experts. Traact isn’t the only company that can help startups stay up-to-date on state compliance. Mosey is another venture-backed startup. DFIN and Vanta are larger companies that offer compliance services.

“These entrepreneurs, founders, they kick the ball and then they run after the ball, they don’t plan, they don’t say I’m going to kick it that direction,” Drummond said. “Everytime they kick the ball there is some kind of compliance to fulfill to not get penalties.”