Price Elasticity of Demand in Startup Formation Services

The pattern of business formation services has changed dramatically over the last decade. As prices have been decreasing over time, we can see that the effect of price on new businesses is growing significantly. This change in cost structure means that people who have never started a company before now have the ability to do so at a much lower cost than in the past. The overall demand for formation services will continue to increase at a rapid pace.

In addition, the data we have from different analysts shows that the demand for LLCs is highly responsive to price changes. The price elasticity of demand for LLC formation services has been estimated at between -1 and -2 in various industry reports. Therefore, if the cost of forming an LLC is reduced by 10 percent, more than a 10 percent increase in new registrations will occur. One example of this occurred when several formation service platforms began offering free LLC formation as a "loss leader", with state filing fees paid by the platform rather than its customers. In less than 12 months after these promotions started, those same platforms experienced an increase of 30 to 50 percent in the number of entities registered on their respective platforms.

So what forces are at work that explain the high elasticity of demand for formation services? There are three major economic forces that converge to create this extreme sensitivity to price. The effects of digital platforms are being felt in all areas of business, including formation services.

The increased availability of remote working after 2020 has reduced the average start-up cost of entrepreneurship for millions of employees. Hence, those employees can start their own businesses in addition to still working for their current employer. As a result, many employees can now work for their company and have the ability to launch other side business opportunities at the same time. With the barriers to entry being lowered, the only remaining barrier was the actual cost of forming a business.

Legal technology companies have raised the level of competition among entrepreneurial firms. With lower pricing, these companies have forced competitors to compress their margins aggressively. Therefore, when companies compete on the price to the zero point for their lowest tier services, the result is that the price elasticity of demand becomes almost perfectly elastic at the margin. In effect, if these companies charged above the price point of $0, their customers would defect from their company immediately.

The availability of information about services has significantly improved the ease of finding and purchasing business formation services for consumers. For example, consumers now shop for formation services, just as they shop for airline tickets. Therefore, we are now witnessing classic Bertrand price competition in which price is the primary determinant of value.

The continued evidence from Delaware demonstrates that Delaware is the premier model for proving out these forces. Although Delaware charges $90 in state filing fees (which is higher than the national median), it continues to be the state of incorporation for approximately 68% of all Fortune 500 companies and a comparatively high number of venture-backed startups. Delaware's continued success can no longer be explained solely by price insensitivity; rather Delaware is continuing to dominate this space due to the differentiation of its product offering, i.e., the Delaware Court of Chancery, predictable case law, and investor familiarity with Delaware's unique business entity formation procedures — all of which contribute to the "quality premium" that justifies the higher price point for incorporation in Delaware.

The situation is completely different when considering a new or gig economy entrepreneur forming a single-member LLC in Wyoming or New Mexico. Wyoming and New Mexico have positioned themselves intentionally on price (Wyoming with a $100 filing fee, and no state corporate income tax; New Mexico with a $50 filing fee and no corporate income tax). As a result of positioning Wyoming and New Mexico for price-sensitive LLC-formation customers, Wyoming has seen an increase of almost 47% in new single-member LLC registrations between 2019 and 2023, per data received from the Wyoming Secretary of State's Office. Both of these jurisdictions have launched formation platforms that target this opportunity; their platforms are therefore acting as demand aggregators for LLC formation customers seeking low-cost jurisdictions.

The fundamental price elasticity dynamics are redefining the formation services industry, and this change in price dynamics will fundamentally reshape the way that formation service providers operate and generate revenue. As formation prices continue to collapse to and around the $0 level, it will become increasingly difficult for formation service providers to create a sustainable business model based solely on the generation of formation fees. As a result of the rapid decline in formation service prices, many formation service providers are creating bundled product offerings which include registered agent services, EIN applications, operating agreements, banking partnerships, etc. Many of these providers will charge customers $500 for the new LLC formation service and, in doing so, provide them the added value of extensive financial technology platforms and banking services that provide significant added value to their customer. Whether the bundling of products creates true consumer surplus or simply redistributes margin extraction from formation services by adding additional layers of indirect pricing remains an open question.