Closely Held CorporationDefined with Examples & More

Written By:
Lisa Borga

What is a Closely Held Corporation?

Closely held corporations (often known as close corporations) are businesses in which more than half of the stock is held by only a few individuals.

Under the definition provided by the IRS, a closely held corporation has greater than 50% of outstanding stock held either directly or indirectly by up to five individuals during the latter half of a tax year and is not a personal service corporation.

A closely held corporation can be classified as a C corporation, S corporation, or as a limited liability company (LLC).

As a result, the precise tax treatment of a closely held company may be considerably different depending on its precise tax classification.

What to Know About Closely Held Corporations

Closely held corporations are businesses with the majority of shares owned by only a few individuals.

In some cases, these will include traditional investors; however, in the majority of cases, they are run by family members.

In order to meet the qualifications for closely held status as a publicly-traded organization, a minimum number of shares must be held by people outside of the company, and this may include regular investors.

Share Prices

Due to the significant differences in trading shares in a company with closely held status, these unique shares are referred to as closely held shares.

Sale prices for closely-held shares are generally more stable because they are rarely traded on the open market.

On the flip side, due to the small number of shares available, they hold a lower degree of liquidity and market depth that, in some cases, can lead to greater volatility.

Because of the lack of public trading, closely-held shares are generally not an effective means of raising capital for a company, meaning that these companies will generally have to raise capital through their own operations or may turn to private funders.

For the same reason of a lack of publicly traded shares, the valuation of the company to which the shares belong may be difficult.

However, for investors interested in purchasing closely-held shares, it is often argued that the reduced quantity of trading holds the advantage of reducing irrational market activity caused by unpredictable investors.

Valuation of closely-held shares is difficult due to the lack of shares available on the open market.

Controlling Shareholders

Due to its nature, there are generally only a few controlling shareholders in a closely held company.

In most cases, these controlling shareholders hold their shares for a long time, meaning that there are few chances for any new shareholders to gain a significantly large stake to become controlling shareholders.

In general, only minority stakes will go on the market.

Due to the fact that stockholders who own large amounts of stock in privately held corporations rarely release their stock, hostile takeovers are generally not possible since typically only minority stakes will be traded.

Differences Between Publicly Held Corporations and Close Corporations

Publicly held corporations generally have a large number of stockholders.

This happens because a public company cannot control who buys its stock, and the stock is traded on public stock exchanges.

In contrast, closely held corporations have a limited number of stockholders, and many of these stockholders will keep their stock for a long period of time.

These stockholders often have a lot of influence or control over the corporation as well.

Additionally, closely held corporations are private corporations and restrict who they allow to hold their stock.

Pros and Cons of Close Corporations

• Generally, the people that own most of the shares in a closely held corporation run the corporation as well. This situation gives these stockholders more control over the corporation and its operations.
• Sometimes close corporations are not required to file information returns every year to the IRS. Additionally, closely held corporations might qualify for S corporation status when filing taxes, which would allow income to pass through the corporation to the stockholders, who would then pay income taxes on their share of the income.
• The shares of closely held corporations are not publicly traded, which can limit the ability of a stockholder to sell their shares since they are limited in who they can sell their shares to. Also, stockholders are typically constrained by restrictions on transferring shares that are part of the stockholder agreement.
• Closely held corporations may have more difficulty raising large amounts of capital due to the fact that their shares are not publicly traded.
• Executives of closely held corporations have a lot of control over the company, but they are still bound by their fiduciary duty to act in the interest of the stockholders and the company. This duty means they are not allowed to make decisions for their own personal gain.

Advantages

• Close corporations do not have to file yearly information returns.
• Management has full control over operations.
• Income may be passed through the corporation to the stockholders. Although, in some states, close corporations are treated as C-corporations, and stockholders could be subject to double taxation.

Disadvantages

• Shares of closely held corporations are not listed on public stock exchanges, making them more difficult for stockholders to sell.
• It is more difficult for closely held corporations to raise capital since they cannot sell stock on public stock exchanges.
• Management is not allowed to base their decisions on the opportunity for personal gain.

Close Corporation Examples

Koch Industries

Koch Industries is the largest privately held corporation in the United States.

If it were a publicly-traded company, it would still rank as one of the largest companies in the United States.

However, it is not likely to go public any time soon as Charles Koch has stated that he has no intention of going public and believes that being a privately owned company has allowed the company to concentrate on growth.

Koch Industries is a conglomerate and operates in many different sectors including, energy, chemicals, finance, and plastics, among others.

The corporate headquarters are located in Wichita, Kansas, but it operates in many different countries worldwide.

Hobby Lobby

Hobby Lobby is a large privately-owned retail company.

It sells arts and crafts supplies as well as home décor.

David and Barbara Green own the company.

The company was founded with the intention of operating according to biblical principles.

The owners of Hobby Lobby believed that they were being forced to violate their religious principles when they were being forced to comply with the Affordable Care Act because it provided employees with emergency contraceptives, which they believed caused them to participate in supporting abortion.

Hobby Lobby sued the government because of this and eventually won their case after it reached the Supreme Court.

The Supreme Court ruled that closely held corporations could choose to be exempt from the law due to their religious beliefs because of their rights under the Religious Freedom Restoration Act.

FAQs

How Do LLCs and Close Corporations Differ?

Limited liability corporations are seen as closely held corporations according to IRS rules if they are operating as a partnership.

Although, states do have different rules for what is considered to be a close corporation or an LLC.

Owners of limited liability companies are not held personally liable for the business’s debts.

Additionally, any profits or losses from the company pass through the business and are taxed on the individual’s tax return.

Similarly, the income from a close corporation goes through the corporation to its stockholders.

Do Close Corporations Pay Out Dividends?

Closely held corporations typically do not pay out dividends due to the fact that this would cause shareholders to be taxed twice.

Can the Owners of Close Corporations Leave the Corporation to Others As Part of Their Estate?

Yes, people who own close corporations can leave them to someone in their will.

If there is no will, the close corporation will go to their heirs.

Final Thoughts

Closely held corporations are companies in which a majority of the shares are possessed by a limited number of individuals.

These shares are not publicly traded on any of the stock exchanges, so members of the public are not able to purchase these stocks.

The people who control a majority of the business’s shares have a large amount of influence on the company as well as a significant amount of control.

But, the shareholders of closely held corporations don’t get the same advantageous tax treatment that the stockholders of companies whose stock is actively traded do.

Key Takeaways

• A closely held corporation is a company with only a small number of shareholders.
• Though stock in a closely held company may be publicly traded at times, this is typically an infrequent occurrence.
• Closely held corporations typically do not face a high risk of hostile takeovers due to limited trading and the difficulty of gaining a controlling interest.