Closed CorporationExplained & Defined with Examples

Written By:
Lisa Borga

A closed corporation, also known as a privately held company, closely held corporation, incorporated partnership, or family corporation, is a company that is owned by a small number of shareholders and is not traded on a public marketplace.

If a company meets these standards, it may elect to be classified as a close corporation.

This allows it to be run by its shareholders without the strict requirements of standard corporations, such as appointing a board of directors and holding regular meetings.

Close corporations are provided for by state statutes, which means rules may vary on a state-by-state basis.

In certain states, there are no provisions for closed corporations at all.

Closed Corporations Explained

A company may choose to structure as a closed corporation in order to achieve the same protection from liability as a traditional corporation while retaining most of the flexibility associated with a partnership.

A closed corporation generally has few reporting requirements and does not have to create financial statements.

This reduced transparency can be a significant benefit when it comes to competition as it can allow a company to avoid disclosing its plans and offer significant flexibility in operations.

Free from the pressure of shareholders, a closed corporation does not need to explain its actions and how they could impact revenue or set regular profit targets.

However, companies may rather choose a traditional corporation in order to benefit from easier access to public investment.

With a closed corporation, the limited ability to raise funding through selling equity shares or bonds can significantly limit their ability to raise capital for expansion or investment opportunities.

Requirements to Qualify as a Closed Corporation

There are some requirements a company must meet in order to qualify for closed corporation status.

Exact requirements may vary significantly by the state in which a company operates.

However, some common requirements include:

• A Small Number of Shareholders: Most commonly, a closed corporation may have at most 35 shareholders
• A Unanimous Resolution: Most states require the shareholders to mutually agree to adopt closed corporation status.
• A Written Agreement: Most states require a written agreement between shareholders outlying specifically detailed of the company’s status.

Not every state offers closed corporation status as an option for business structure, so if a business will form in a specific state, it is important to get in contact with its Secretary of State to see if this structure is an option.

Though state laws change regularly currently, the states where closed corporations are a recognized option include; Alabama, Arizona, California, Delaware, Georgia, Illinois, Kansas, Maryland, Missouri, Montana, Nevada, Pennsylvania, South Carolina, Texas, Vermont, and Wyoming.

Pros & Cons of a Closed Corporation

When choosing any business structure, owners should carefully consider all of the potential advantages and disadvantages, and closed corporations are no exception.

Pros of a Closed Corporation

Some of the advantages of choosing a closed corporation include:

• Limited Liability: With a closed corporation, the shareholders of the company are not personally liable for the debts of the corporation. This means that if the company were to face a lawsuit or business failure that it was incapable of paying for the shareholders personal assets and could not be held liable under normal conditions.
• Limited Reporting Requirements: A closed corporation does not need to craft annual financial statements and profit reports or hold annual meetings and record minutes. This can reduce the burden and cost on the company that would otherwise be incurred in order to create these documents and help keep the company’s actions secret.
• Closer Control: Generally, the shareholder agreement that most states require in order to create a closed corporation will include rules for the buyback of stock in cases where a shareholder wishes to liquidate their shares or passes away. It may also have rules regarding the transfer of stock in cases such as divorce in order to prevent outsiders from becoming a part of the corporation.

Cons of a Closed Corporation

There are certain disadvantages to consider before choosing a closed corporation structure.

These include:

• Reduced Ability to Raise Capital: Without the ability to sell stock on public markets, a closed corporation has little opportunity to raise capital from investors. This means capital must come primarily from operations, bank loans, and the company’s shareholders. This can significantly limit opportunities for expansion.
• Limited Options for Liquidation: Generally, a closed corporations shareholder agreement will include a restriction on the divesting of shares. In most cases, this will restrict shareholders to only selling their shares to existing shareholders. This can greatly limit a shareholder’s ability to earn a profit from their shares and creates a limit on the number of individuals that may be willing to purchase shares.
• Potentially Increased Taxation: The IRS will tax a closed corporation as a C corporation except in cases where the owners request and are qualified to be taxed as an S corporation. This means that a closed corporation could be subject to double taxation.
• Fewer Options for the State of Incorporation: Not all states offer a closed corporation structure as an option for business owners. Though business owners could choose to incorporate in a different state, this limits the potential options a state can choose to incorporate in.
• Reduced Representation for Minority Shareholders: In a closed corporation with few shareholders, a minority shareholder may have little say in decisions affecting the company. However, state rules do generally require closed corporations to have processes in place to address grievances should a shareholder feel that management is not acting in the company’s best interests.

Closed Corporations Vs. Traditional Corporations

The choice between a closed corporation and a traditional publicly-traded company is an important one for business owners.

There are many key differences between these two options, and some of the most important to consider include:

• In many states, traditional corporations are required to hold annual meetings for shareholders, during which they will elect a board of directors. A closed corporation has no such requirement.
• A traditional corporation’s board of directors generally must meet regularly and appoint corporate officers according to strict requirements for corporate structure. These officers will then generally run the daily operations of the company. A closed corporation generally does not have a board of directors or requirements for the structure.
• Traditional corporations typically face strict reporting requirements, including annual financial statements and minutes for both the annual shareholder’s meeting and meetings of the board of directors. These will generally then be submitted to the secretary of state in the company’s state of formation. Closed corporations may have to submit some annual paperwork, but it is generally far more limited.

Closed Corporation Examples

There are many closed corporations operating in every industry across the planet.

These include some extremely recognizable examples such as PricewaterhouseCoopers, Koch Industries, and Hearst Corporation.

There are several examples of non-U.S. closed corporations as well, including IKEA from Sweden and Bosch in Germany.

Key Takeaways

• Close corporations cannot be traded on public marketplaces and, as a result, cannot easily receive public investment.
• Close corporations are held by a small number of shareholders, often comprised of the company’s managers and their family members.
• Due to the small number of shareholders who typically have direct involvement with the business, close corporations typically operate similarly to a partnership.
• Closed corporations typically face fewer requirements pertaining to transparency and reporting; however, due to the lack of public trading, shareholders may have difficulty liquidating their assets.