Close Corporations

For many corporations, the ultimate goal is to establish a reputation and develop a product that will eventually allow them to “go public,” opening up their stock to owners across the country or allowing more shareholders to buy into the company as an investment. For some, however, control over the corporation is a top priority, and original owners or investors may be interested in keeping the ownership of the corporation as tightly controlled as possible. For these types of owners, a close corporation can be an ideal option.

Elements of a Close Corporation

Close corporations, also known as “tightly held” corporations, are businesses where the owners, directors, officers, and shareholders of the company often share overlapping roles, allowing them to remain a small and tight-knit group. They are limited to no more than 30 shareholders, and there are often significant restrictions on the ability of existing owners and shareholders to transfer or sell stock in the company. Close corporations cannot make public stock offerings, and usually existing shareholders must unanimously agree to operate as a close corporation.

Close corporations are ideal for businesses that are run as family ventures, or those based on certain moral or religious principles that play a central role in the vision of the business and its ownership. A close corporation can be registered as a C corporation or as an S corporation if it follows the IRS filing procedures for the relevant business form.

Setting Up a Close Corporation

Close corporations can be formed relatively easily if a business meets the elements set forth above. Assuming all shareholders agree to close corporation status, the corporation files as a close corporation with the state of incorporation. State laws on close corporation filings vary, and it is important to check the laws of the state in which you reside. Once close corporation status is established, the corporation can be run similarly to a partnership, where the shareholders and directors are involved in the day-to-day management of the corporation and have a significant say in the affairs of the business.

Benefits and Challenges of a Close Corporation

Many small business owners and families find close corporation status advantageous because it allows them to bypass the formalities and restrictions normally placed on corporations. For instance, when a corporation is owned by only three or four business family members, it may seem unnecessary to provide notice of formal annual meetings for the corporation. Close corporation status eliminates this meeting requirement, as well as increasing the amount of authority and power that shareholders wield. In a close corporation, shareholders may often override the authority of officers or directors of the corporation, if needed. However, in exchange for this freedom and authority, close corporations impose restrictions on the ability of shareholders to sell their ownership in the corporation and often require that other shareholders be provided with a right of first refusal before shares can be sold to an outsider. Close corporations are also often more expensive to form than C or S corporations because they require expertly drafted shareholder agreements that set forth the restrictions and requirements of the close corporation shareholders.