What is true about a closely held corporation?

A closely held corporation is a corporation in which just a few individuals hold more than half of the shares.​

Learn more about closely held corporations, how they work, and their pros and cons.

Closely held corporations are businesses where a few individuals own the majority of shares.

• Alternate name: Close corporation

The vast majority of small corporations in the U.S. are closely-held. To qualify as a closely held corporation, a business must fit the following requirements:

• Have more than 50% of the value of its outstanding stock owned, directly or indirectly, by five or fewer individuals at any time during the last half of the tax year
• Not be a personal service corporation

A personal service corporation is owned by service professionals like physicians, architects, attorneys, and other similar professionals.

A closely held corporation, by definition, is a private corporation because its shares are not traded publicly on a stock exchange. The shareholders may be family members, business partners, or any small number of investors. A closely held corporation is a private corporation, but a private corporation may or may not be closely held; the critical distinction is the number of shareholders.

The following characteristics describe the features of a closely held corporation:

• Few shareholders
• Limited number of shares (set by individual states)
• Informal operating structure
• Shareholders operate the business
• Decisions are made based on the shareholder agreement

A closely held corporation may be a C corporation or S corporation, which is an important classification for tax reasons. If you form a closely held corporation, and it meets the IRS criteria for S corporation status, all profits are passed through to the owners' personal tax returns. If it's classified as a C corporation, it will be subject to regular corporate taxes, and owners will also be responsible for paying personal taxes on the income received from the corporation.

To qualify for S corporation status, a business must apply with the IRS by submitting Form 2553.

Closely held corporations that are not S corporations can apply the passive activity rules, which limits owners' loss from passive activities to their passive activity income. If a shareholder doesn't serve on the board or work in management, that would be considered passive.

There are also at-risk rules that limit owners' losses from activities to their amount at risk in the activity. The risk can be equal to the amount of money contributed to the activity or any amount borrowed for it.

Pros

• Less regulations

• More control

Cons

• Process of selling shares

• Harder to raise money

• Taxes

• Less regulations: Closely held corporations don't have to abide by as many corporate regulations as publicly traded companies, which are regulated by the Securities and Exchange Commission. This allows them to forgo many formalities like filing financial statements.
• More control: Since there are few shareholders, owners have more control over the company. They can make business decisions without consulting with a board of directors or relying on public shareholder votes. This allows them to run the company how they want.

• Process of selling shares: Unlike publicly traded companies, closely held corporations can't list their shares on a public stock exchange; if one of the shareholders wants to sell some or all of their shares, the pool of potential buyers is minimal. Even once a potential buyer and seller connect, there is a chance that they disagree on the company's value.
• Harder to raise money: Not being able to sell shares on a public stock exchange limits the way closely held corporations can raise money. The business generally relies on capital contributions from its owners.
• Taxes: State laws vary regarding closely held corporation classifications. If the business is in a state that treats closely held corporations as C corporations, owners could face double taxation. The company pays taxes on profits, and the shareholders pay personal income taxes.

• Closely held corporations are companies where five or fewer shareholders own the majority of the company.
• Closely held corporations can be C corporations or S corporations.
• Shares of closely held corporations are not publicly traded on stock exchanges. 
• Shareholders possess more significant control over company decisions in a closely held corporation because of the limited number of shares.

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July 12, 2022

A closely held corporation is a business owned by a small group of shareholders. This type of business is also called a closed corporation. Generally, for a corporation to be considered a closely held corporation, at least half of its shares must be under the ownership of no more than five people. Often, closely held corporations are family businesses. Closely held corporations are private corporations whose shares are not listed on a public stock exchange. Additionally, trading activities associated with closely held corporations are usually limited as most of the stock is held by people like private investors or family members.

If you are in the process of starting a new business, you might be considering a closely held corporation. But is this business structure right for you? In order to determine if a closely held corporation is the right business structure for you, review its advantages and disadvantages.

A closely held corporation can have several benefits. The following are some of the advantages of a closely held corporation;

A closely held corporation allows the owners to have a huge say over the fate of their business. You will retain significant control as a majority owner in a closely held corporation.

More control comes with more freedom. In a closely held corporation, there is the freedom to try new ideas and take risks. Also, depending on how a closely held corporation is structured, executives may not be required to explain how they spend every dollar or why they tried something that did not succeed.

Usually, closed corporations can take advantage of statutory corporation rules. With a closely held corporation, you can obtain many of the benefits of incorporation while still being able to run your company without needing to meet certain corporate formalities.

Just as is the case with advantages, closely held corporations can have several disadvantages. Below are some of the disadvantages of a closely held corporation;

It might be challenging for a closely held corporation to get money for expansion and growth. Usually, closely held corporations get funding from shareholders' contributions and by generating profit. Using share equity to raise capital is challenging because the shares of a closed corporation are not on a public stock exchange for investors to purchase. However, if a closely held business has good revenues and a good reputation, it is possible to get loans.

It can be challenging for shareholders in a closely held corporation to sell their shares because shares are not on a public stock exchange. When shares are on a public stock exchange, it is easy to find a buyer since buyers are available throughout. Additionally, it can be challenging for a shareholder in a closely held business to sell their shares if the shareholder agreement contains restrictions on the transfer of shares. Most closed corporations have shareholder agreements with such restrictions.

With few shareholders, it means that each person shoulders more legal liability for the corporation’s actions.

To learn more about the advantages and disadvantages of a closely held corporation, so you make the right decision, contact our business law attorneys at SAC Attorneys LLP.