Closely Held Corporations: Definitions, Characteristics, and Liability

Shelly Bohorquez  | 

What Is a Close Corporation?

A closely held corporation or “close corporation” is a relatively small C or S corporation whose majority stock is directly or indirectly owned by a very limited number of individuals. Five or fewer stockholders typically own over 50 percent of the corporation, which is why it is often referred to as a “privately held” corporation.

Although small portions of stock for these corporations may be traded, large percentages of stock are not exchanged frequently, which means the same few individuals are usually in control of the company.

Characteristics of a Close Corporation

Close corporations are one of the most common types of general corporations, and are defined mostly by the amount of people with a controlling number of company shares. Other defining characteristics include: limited numbers of stock based on state law, a somewhat informal operating structure, minimal actively traded stock and not being a personal service corporation.

Shareholders

Shareholders of close corporations often operate the business themselves, as opposed to other corporations, which are run by a board of directors. This design allows for a more informal operating structure, as the shareholder agreement determines how decisions are made and places restrictions on the sale of stock.

In a close corporation, 50 percent or more of the company stock is owned by five or fewer individuals, which means that a small group of individuals are typically in control of these privately held corporations.

Pros and Cons of a Close Corporation

One of the major benefits of a close corporation is the flexibility of its operation, which demands less time and paperwork from the shareholders who control the company. Because the company is controlled by such a small number of individuals, they are able to serve as the board of directors.

Although this less formal business environment is often preferable, a general corporation may be a better option if the business owners are hoping to open stocks for purchasing by the public.

The drawbacks of a close corporation go hand in hand with this; because of the limitations on the number of shareholders for this type of corporation, these businesses are unable to grow the way general corporations can through public offerings and selling of shares.

Tax laws for privately held corporation are also more complex for shareholders than those of general corporations. The application of tax laws differ for shareholders who are active and passive, or those who are actively involved in the company’s business decisions and those who are not.

Liability in a Closely Held Corporation

These differentiations between shareholders means that liability for the corporation’s decisions varies based on a shareholder’s level of involvement with the company. Unlike an LLC, which taxes shareholder dividends on their personal income tax, closely held corporations are taxed as either C or S corporations, but may only be able to claim company losses if they are actively involved as members of corporation’s board of directors.

However, these laws are generally pretty complicated, so if you are trying to determine the proper company structure for your business endeavor, it’s important consult a corporate lawyer for your specific situation.


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This post was updated February 28, 2019. It was originally published December 13, 2018.