Closely Held Corporation: Pros of a Closely Held Corporation

According to the IRS, a closely held corporation is a corporation in which five or fewer individuals own more than 50 percent of its outstanding stock as of the second half of the tax year. Closely held corporations may not be personal service corporations (such as a law firm owned by the lawyers in the firm).

C-corporations, S-corporations, limited liability companies (LLCs), and small businesses may fall under the closely held banner. Closely held publicly listed corporations (with shares of stock available for trade on public stock exchanges) typically have a limited number of shareholders who infrequently trade their shares.

Closely held corporations are subject to specific tax treatment limitations regarding at-risk rules, passive activity losses, and officer compensation. The IRS, however, doesn't keep track of the number of closely held corporations.

Closely held corporations share a few elements in common, including:

1. 1. Small number of shareholders: A small number of shareholders, who hold the company stock, typically control closely held corporations. Often, these controlling shareholders are family members who maintain their ownership for a long period, providing stability to the company. In many cases, this means that corporate decisions are typically made based on the interests of the corporation rather than for blocks of shareholders.
2. 2. Limited trading of shares: The shares in a publicly held close corporation are rarely traded, adding to the stability of the company. Since the majority stockholders hold on to their corporate stock, there's little chance of anyone executing a hostile takeover.
3. 3. Stable share prices: Share prices of closely held corporations tend to be stable as well since share holders rarely trade them. They're less subject to the whims of the market or uninformed investors. However, the lack of trading can also make it difficult to accurately value a closely held corporation.

While the IRS's treatment of closely held corporations is uniform across the United States, the definition may vary from one state to the next. For example, Florida doesn't distinguish between closely held corporations and any other type of corporation, while Delaware specifically defines "close corporations" as those with thirty or fewer shareholders. Understanding the relevant state laws is vital to knowing whether being closely held makes a difference in how you conduct your closely held business.

Here are a few benefits of this type of business entity:

1. 1. Shareholders have greater control. In a closely held corporation, shareholders have control over decision-making and operations. If the company is a private corporation, it's not required to comply with US Securities and Exchange Commission (SEC) rules, and shareholders don't have to prioritize maximizing profits. This allows them to reinvest in the company in any way they choose or even donate profits to charity or take dividends and bonuses. Shareholders of a closely held corporation also retain tight control over the sale of shares.
2. 2. There’s more room for risks and new ideas. Closely held corporations also have greater freedom to take risks or try new ideas. Officers, directors, and business owners don't have to answer to shareholders and may not need to account for the potential failure of a new venture. In some smaller business corporations, stakeholders can spend money as they choose without strict accountability built into the corporate structure. The freedom of closely held corporations extends to the C-suite as well, where formal structures, including a Board of Directors, are often not needed or utilized.
3. 3. Tax reporting may be simpler. Many closely held corporations are S-corporations, allowing corporate income to pass through to owners and shareholders who declare the income on their personal tax returns and are then responsible for the income tax on their earnings. Because the tax burden is on the shareholders and not the corporation, the S-corp may not even need to file a corporate tax return in some cases. In many states, closely held corporations also don't have to file annual information statements.

While there are benefits to running a closely held corporation, there are also disadvantages, including:

• Raising capital may not come easily. Closely held corporations, especially private companies, can have a harder time raising capital. The company can't raise money by selling shares, and if the company's an S-corp, it can't hold an initial public offering to raise funds. Instead, closely held corporations are typically limited to raising capital from existing shareholders and generating profit as a source of capital. While closely held corporations may be able to take out business loans, they can't use their share equity to raise capital.
• Selling a closely held corporation can be difficult. This is, in part, because there’s often no clear indication of the company’s value. Buyers aren't readily available for these companies, and individual shareholders don't have a market if they wish to sell their shares. Complicating matters further, the shareholder agreement governing a closely held corporation often restricts the sale of shares. Often, privately held corporations must go public to accomplish a sale.
• There are restrictions. While executives and shareholders have a great deal of freedom in a closely held corporation, they still have a fiduciary duty to make decisions in the corporation's interests rather than their own. Shareholders' agreements in a close corporation can restrict that freedom in many ways, and minority shareholders may find themselves locked out of decision-making by majority shareholders. In addition, shareholders may be legally liable for the acts and omissions of the corporation, even if they have no knowledge of those acts.

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