Business

What Is a Closely Held Corporation? Explained for Business Owners

A closely held corporation is a type of business where more than half of the stock is in the hands of five or fewer individuals during the second half of a tax year, the IRS says1. This setup blends elements of small businesses and private corporations, allowing major shareholders to make key decisions. Companies like Hobby Lobby and Chick-fil-A benefit from this by keeping control and stability in the hands of a few. This understanding helps you make the most of what closely held corporations offer.

Running a closely held corporation has its perks. It offers more control over the company and protects against takeovers1. Because shares aren’t widely traded, share prices tend to be more stable. This is a plus for business owners. This approach is similar to family-owned businesses, where the success of the company directly affects shareholders.

Key Takeaways

  • A closely held corporation has 50% or more stock owned by up to five individuals1.
  • Shareholder control in business decisions is significantly high.
  • The corporate entity structure ensures limited share trading and higher share price stability1.
  • Closely held corporations like Hobby Lobby and Chick-fil-A emphasize strategic stability1.
  • Management often mirrors small business ownership dynamics.

Definition of a Closely Held Corporation

Understanding a closely held corporation is crucial in the complex world of business ownership. Such companies stand out because they don’t have many shareholders. The way they are set up and run is also special.

IRS Definition

The IRS says a closely held corporation is one with at most five people owning over half the stock by mid-year2. These aren’t like personal service companies. Instead, they can be various types of businesses, like normal or special close corporations. They get certain management perks and might save on taxes3. This arrangement keeps business ownership focused, with only a few holding the stock.

General Business Classification

A closely held corporation is usually private and doesn’t trade its stock publicly. This ensures that stock stays with a small group of owners3. For example, in Texas, these corporations can have up to 35 shareholders. They’re not allowed to list their shares on big stock exchanges4.

This shareholder setup is quite different from public companies, where stock is more spread out. Such a structure can lead to distinct business types and tax situations. These factors affect how the company operates and its financial health.

How Closely Held Corporations Differ from Publicly Held Corporations

It’s important to know how closely held and publicly traded corporations vary. This knowledge helps us understand the stock market better. Closely held corporations keep share distribution tight. In contrast, publicly traded corporations let more people buy shares, making trading easier.

Share Distribution

Closely held corporations have fewer shareholders, often not over 35. This is very different from big companies like Apple with thousands of shareholders, where your share is just a tiny part of the company5. The IRS says if five or fewer people own most of the company, it’s “closely held”. This affects how taxes work for them, unlike in publicly traded companies3. People who own shares in closely held corporations can make big decisions. This isn’t something you often see in companies with shares all over the place5.

Market Liquidity

The ease of selling shares is another big difference. Shares in closely held companies are harder to sell. They’re not on the big public stock exchanges3. This makes it tough to figure out how much they’re worth or to sell them, unless maybe to other current shareholders or back to the company itself5. Public companies have it easier here. Their shares can be bought and sold quickly on the stock market, showing a clear split in how these two types of companies work.

Closely held corporations let their managers, often big shareholders, have more say in what happens day-to-day. But, they bump into issues like not being able to sell shares easily or raise new money as public companies can35. Knowing these differences helps paint a better picture of their economic impact.

Characteristics of Closely Held Corporations

Closely held corporations stand out because they keep things within a tight circle. They normally have no more than 30 shareholders. This group might include family members or close friends, showing a liking for a tight-knit investor community67. This way, the control over the company stays in familiar hands.

Shareholder Concentration

These companies keep their shareholder circle small. This ensures that everyone’s goals are aligned. If someone wants to sell their shares, others in the group get the first chance to buy them. This keeps the company’s control steady and unchanged6. Also, because their shares aren’t sold in the public market, their prices stay more stable. The ups and downs of the market don’t affect them as much7.

Insider Trading Considerations

Insiders have a big impact on closely held corporations. Any share sale or transfer gets a close look to avoid unfair practices or breaking rules. This careful watch helps the company follow trading laws and avoids insider trading problems. Also, the company’s value remains stable, protecting it from big market changes7.

What makes closely held corporations special is their focus on a select group of shareholders and strict share transfer rules. These ensure a stable and controlled business setting. Inside dealings and trade rules are designed for fairness and rule following. This protects everyone’s interests.

Advantages of Closely Held Corporations

Closely held corporations offer many advantages, particularly for those who seek control and autonomy in business. Being a business owner in such a setup lets you greatly influence decisions. This is key for reaching your big goals. These companies are usually owned by a few individuals or families, making control easier than in public companies8.

A major perk is the chance for S-Corp tax benefits. Choosing an S-Corporation tax classification lets shareholders put income on their personal taxes. This skips the need for corporate federal tax filings8. For small businesses, this helps a lot with managing money better.

These corporations also protect against unfriendly takeovers. With shares held by a few, it’s tough for outsiders to take control by buying stock8. This keeps the business on its original path, ensuring it stays true to its vision.

For small business growth, keeping most shares with family or close associates is beneficial. It allows for quick decision-making. This aligns with the owner’s vision, promoting steady growth9.

Furthermore, these businesses can choose close corporation status for more flexibility and fewer formalities, like less frequent board meetings. This status aids in streamlining governance. It improves your capacity to control strategy and make impactful decisions for your firm’s success.

Disadvantages of Closely Held Corporations

Closely held corporations come with big downsides. One key problem is capital raising challenges. Since their shares aren’t sold on the public market, it’s very hard to bring in outside money by sharing equity. This makes it tough for the company to grow since it relies on shareholders’ money and profits9. Due to these limits, getting enough money for big growth is hard for these businesses10.

Share transfer restrictions are another big hurdle. Agreements between shareholders often set rules on how and when shares can be passed on. This can stop shareholders from selling their shares easily, mainly because there’s no public market for them9. Because of this, it’s harder for shareholders to turn their shares into cash. This also makes the company less appealing to potential new investors10.

Moreover, people in charge of these corporations have to follow fiduciary duties. They must look out for the company’s best interests, not their own personal gains. This can get tricky when business mixes with family interests, which is common in these firms10. If personal interests interfere with company decisions, it could lead to legal problems10.

To sum up, despite their control and independence, the capital raising challenges, share transfer restrictions, and strict fiduciary duties make it tough for closely held corporations to do well. Business owners should really think about these drawbacks before choosing this corporate structure.

Examples of Closely Held Corporations

Closely held corporations mix personal beliefs with business. Hobby Lobby and Chick-fil-A are key examples because of their Christian values.

Hobby Lobby

Hobby Lobby shows how faith shapes business decisions. Owned by the Green family, it follows Christian principles daily. One major event was its health benefits case, leading to a Supreme Court victory. The Court supported Hobby Lobby’s religious rights under the Religious Freedom Restoration Act (RFRA)11. This shows how owner beliefs influence company policies.

Chick-fil-A

Chick-fil-A represents the mix of ownership and Christian values too. The Cathy family has woven their faith into the company from the start. Its unique feature is closing on Sundays for rest and worship. This comes from founder Truett Cathy’s beliefs12. It shows their dedication to employee well-being through religious values.

Hobby Lobby and Chick-fil-A prove personal values shape family businesses. They blend owner beliefs and business in special ways. This highlights their uniqueness in the business world.

Tax Considerations for Closely Held Corporations

Closely held corporations can choose between S-Corporation and C-Corporation tax statuses. Each option has its own pros and cons. Understanding these can help in making a smart choice.

S-Corporation Election

An S-Corp status allows earnings to go straight to shareholders. This avoids taxes at the corporate level. Avoiding double taxation, where profits are taxed at both levels, is a big advantage here13. S corporations are very popular with small businesses. They can pick S status if they meet certain conditions, like having up to 100 shareholders13.

Proper documentation of S corporation status is vital. It ensures the tax status and entity type are correct. This protects future buyers13. Selling S corp stock can lead to long-term capital gains, taxed favorably13. Buyers often prefer buying assets for tax benefits such as better deductions13.

C-Corporation Taxation

C-Corporation status means the corporation is taxed as its own entity. It pays corporate taxes on its income14. This can cause double taxation: once on corporate profits and again on dividends to shareholders14. Partnerships report differently, with owners reporting their share on their own taxes, like S-Corps14.

Switching from a C to an S corp can lead to a built-in gains tax if assets are sold too soon13. But, an F reorganization can prevent these tax problems. It lets shareholders transfer stock to a new company in exchange for its shares13. Knowing the intricacies of C-Corp taxation can help with strategic planning and reducing taxes on dividends.

Management and Control

In closely held corporations, management and control are unique because a few shareholders own most of the company15. Major shareholders have big influence, actively guiding corporate governance and key decisions. For example, at EcoFriendly Furniture Inc., the Johnson family owns all the shares. John has 45%, Jane has 25%, Jim holds 20%, and Mary has 10%. This way, the shareholders’ voting power blends with daily management.

Major Shareholders’ Influence

The role of major shareholders is crucial in closely held corporations15. The Johnson family’s involvement at EcoFriendly Furniture Inc. boosts ethical management by aligning decisions with the firm’s values and aims. This creates a culture of shared responsibility and transparency, aiding growth and stability.

Fiduciary Duty

Significant fiduciary duties fall on major shareholders16. They must ensure their decisions favor the company’s interests over their own. As ownership and management merge, strong governance is essential to avoid conflicts and stick to ethical business practices. This approach keeps power in balance, securing shareholder rights and ensuring fairness and transparency.

Closely Held Corporations and Hostile Takeovers

Closely held corporations have a big plus in keeping away unwanted buyers. They are set up so a few people own most of the shares. This setup means it’s hard for outsiders to buy enough shares to take over17.

Such tight control helps keep the company’s independence. It lets shareholders think about growing the business, not just fighting off buyers. This ownership setup shields them from hostile takeovers and proxy battles17.

The stability of share prices also helps protect the shareholders. Since there’s less trading, share prices match the company’s real performance better. This makes the company less tempting for those who might want to take it over18.

These corporations often get money from private investors like venture capitalists. This way, they can grow without losing control. Their unique financial backing helps them fight off hostile takeovers even more18.

Conclusion

This overview teaches us about a special way to own a company. It shows how this method helps in making important company decisions. Unlike other companies, here, a few people own and control everything. They can make plans that truly show what they believe in. Shareholders and leaders in such companies in Washington State must always act in the company’s best interest. They work closely together19.

This type of company setup has its good and tough sides. These companies can decide how to run things on their own. But, they might find it hard to get money when needed. The worth of these companies is usually based on actual profits. This asks for smart money decisions, not just guesses20. Still, it’s a good choice for entrepreneurs wanting more control over their business.

Taxes also play a big part in choosing this business model. In Sweden, for example, company profits may be seen as income from work. This affects how much money entrepreneurs take home. Those interested in this model must think about taxes. They also need to consider how it ties with their long-term plans and how it helps their business grow21.

Source Links

  1. Closely Held Corporation: Definition, Types, and Examples – https://www.investopedia.com/terms/c/closely-held-corporation.asp
  2. Closely Held Business Disputes Between Owners – https://www.thebusinesslitigators.com/closely-held-business-disputes-between-owners.html
  3. Pros and cons of a closely held corporation – https://www.legalzoom.com/articles/pros-and-cons-of-a-closely-held-corporation
  4. Ask A Houston Business Lawyer: What Is A Closely Held Corporation Under Texas Law? | Henke & Williams LLP – https://www.henkelawfirm.com/blog/litigation/business/ask-a-houston-business-lawyer-what-is-a-closely-held-corporation-under-texas-law/
  5. WHAT IS THE DIFFERENCE BETWEEN A CLOSELY HELD CORPORATION AND ONE THAT IS PUBLICLY TRADED? – Schwartz Law Firm – https://schwartzlawfirmpa.com/what-is-the-difference-between-a-closely-held-corporation-and-one-that-is-publicly-traded/
  6. What is a Close Corporation? – https://www.delawareinc.com/what-is-a-close-corporation/
  7. What is a Close Corporation? Meaning, Structure, and Taxation – https://motivalaw.com/what-is-a-close-corporation/
  8. Closely Held Stock: What It Is, How It Works, Benefits – https://www.investopedia.com/terms/c/closely-held-stock.asp
  9. Advantages and Disadvantages of a Closely Held Corporation – https://www.sacattorneys.com/articles/advantages-and-disadvantages-of-a-closely-held-corporation/
  10. Closely-Held Business Laws – https://www.legalmatch.com/law-library/article/closely-held-business-laws.html
  11. Entities 5 | Internal Revenue Service – https://www.irs.gov/faqs/small-business-self-employed-other-business/entities/entities-5
  12. Closely Held Stock | Planned Giving | Saint Leo University – https://your.saintleo.edu/planned-giving/closely-held-stock
  13. Tax planning and considerations: S corporation targets – https://www.thetaxadviser.com/issues/2022/may/tax-planning-s-corporation-targets.html
  14. Income Tax Issues When Planning for the Sale of a Closely Held Business – Buckley Law – https://buckleylaw.com/article_posts/income-tax-issues-when-planning-for-the-sale-of-a-closely-held-business/
  15. What is a Closely Held Corporation? – https://www.superfastcpa.com/what-is-a-closely-held-corporation/
  16. What is a Closely Held Corporation? – Best Accounting Schools – https://www.bestaccountingschools.net/faq/what-is-a-closely-held-corporation/
  17. Closely Held Shares: Meaning, How They Work, Example – https://www.investopedia.com/terms/c/closelyheldshares.asp
  18. Closely Held Corporation: Everything You Need to Know – https://www.upcounsel.com/closely-held-corporation
  19. Breaches of Fiduciary Duties in Closely Held Companies – https://www.lasher.com/breaches-of-fiduciary-duties-in-closely-held-companies/
  20. Valuation of Securities of Closely-Held Corporations – https://scholarlycommons.law.case.edu/cgi/viewcontent.cgi?referer=&httpsredir=1&article=4136&context=caselrev
  21. Taxation of closely held corporations – efficiency aspects – https://microsimulation.pub/articles/00051

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