What Is a Closely Held Corporation?
A closely held corporation is a business that has more than half of its stock owned by a few people. Using the IRS's definition, a closely held corporation is a non-personal service corporation that has 50% of its outstanding stock owned by up to 5 individuals at any point in the last six months of a tax year.
Closely held corporations can have different business classifications, such as a C corporation, S corporation, or an LLC. It's important to note that under the S corporation classification, profits and losses are passed through to the owners. Under the C corporation classification, profits and losses are the responsibility of the corporation.
- A closely held company is a publicly listed corporation that has a small number of concentrated shareholders.
- Trading in these shares is dominated by company insiders, and they tend to be quite illiquid with infrequent volume.
- Closely held companies are at less risk of a hostile takeover since obtaining a controlling interest through equity would be difficult to come by.
- Publicly held corporations have shares of stock publicly traded on stock exchanges.
- Under the Religious Freedom Restoration Act, for-profit closely held corporations, such as Hobby Lobby, are permitted to opt out of certain government mandates when such an order violates its religious principles.
Understanding Closely Held Corporations
Despite the corporation's stock being listed, many transactions between major shareholders and closely held corporations do not receive the same preferential tax treatment as those of corporations with actively traded stocks. Deductions and losses may not be allowed in some instances for parties involved in these transactions.
A closely held corporation, also referred to as a closed corporation, is a firm whose stock is held by a small number of people. While this may include traditional investors, it may also be held by the family members or other insiders associated with a particular business. To qualify as a publicly-traded company with closely held status, a minimum number of shares must be held by persons outside the business, such as members of the public at large.
The shares of a closely held company are known as closely held shares.
Since shares are not often traded on the open market, share prices of closely held companies tend to be more stable. On the other hand, since fewer shares are outstanding for public trading they may also experience less liquidity and depth of market, making them more volatile.
The share price for a closely held corporation is set by its founders and is often calculated by diving the amount raised by the number of shares to be issued.
Still, some argue that there is less influence from irrational market activity on the price because trading is so limited. This prevents the business from being subject to the whims of average, uninformed investors, who can be unpredictable in nature, though it comes at the cost of being more difficult to raise additional capital through the sales of associated stock.
It is also difficult to properly value the company. The lack of shares on the open market makes it challenging to get the information necessary to make such estimates.
The closely held company is often controlled by a small number of large shareholders because they own the majority of the shares. Most often, these shareholders maintain their investments over the long term, resulting in few opportunities for new investors to acquire a large enough stake to become a controlling member, as only minority stakes tend to come available for trade.
When these shareholders affect transactions, tax implications and controlling interest concerns will often come into play, as will insider trading disclosures.
Since the majority shareholders rarely release any of their shares, this makes it difficult for an outside entity or corporation to attempt a hostile takeover, as only a minority stake is regularly traded. This can provide a sense of stability because all decisions made on the behalf of the business are solely for the interest of the business itself.
Closely Held vs. Publicly Held Corporations
A closely held corporation has few shareholders. These shareholders typically hold their shares for the long term and have significant control in or influence on the company. The closely held corporation is often a private corporation, with restrictions on who can hold shares.
A publicly held corporation typically has many shareholders; as a public company, they cannot restrict who can obtain shares, which are listed on public stock exchanges. In contrast to a closely held corporation, its shareholders often have limited influence on operations and decisions.
Advantages and Disadvantages of Closely Held Corporations
Often, those who run the closely held corporation are the shareholders that hold most of the company's shares. Because of this dynamic, they have greater control over operations and decision-making.
Closely held corporations, where permitted, may be able to forgo filing information returns to the IRS annually. In addition, the closely held corporation may qualify as an S corporation for tax purposes, allowing income to be passed through to shareholders and/or owners. In other words, pass-through income places the tax burden on the shareholders rather than the corporation.
Because shares are not listed on a public exchange, the closely held corporation does not have the same opportunity as a public company to raise significant amounts of capital for projects and expansion. In addition, shareholders may encounter difficulties selling their shares as the pool of potential shareholders is limited. Lastly, these existing shareholders are often bound by certain shareholder agreement restrictions pertaining to transferring shares.
Although executives have control over the operations of the company and the decision-making process, they are still required to exercise great care when making decisions. It is their fiduciary duty to act in the interest of the corporation and its shareholders like any other corporation. This fiduciary duty prevents them from making decisions for personal gain.
Management maintains full control of operations.
The corporation passes through income to shareholders.
Closely held corporations avoid filing annual information returns.
Share equity does not yield as much capital as public corporations.
Management cannot make decisions for personal gain.
Shareholders may not freely be able to sell their shares.
Examples of Closely Held Corporations
Hobby Lobby is a United States-based arts and crafts and home decor store, owned by David and Barbara Green. With more than 900 stores in 47 states, it is the largest privately-owned retailer of its kind in the world. Hobby Lobby was founded upon and operates according to Biblical principles, those of which have come under fire in the recent decade.
Under the Affordable Care Act, companies—except for religious organizations and religious employers—were ordered to provide health benefits, including contraceptive methods, to their employees. As a result, Hobby Lobby, deemed a for-profit company, was not exempt from this order. However, operating as a closely held corporation and not for the interest of the public, Hobby Lobby countered this mandate, arguing that it violated the religious principles of its owners.
In response to its lawsuit, the Supreme Court ruled in favor of Hobby Lobby, citing that Hobby Lobby is a person and that the mandate violated for-profit, closely held corporations' rights under the Religious Freedom Restoration Act (RFRA) of 1993.
Chick-fil-A is a family-owned fast-food restaurant chain founded by Truett Cathy in 1946. Known for its famous chicken sandwiches and being closed on Sundays, it is one of the most popular closely held corporations in the United States.
The Cathy family remains at the helm, serving in all executive positions. Its leaders have no plans to take the company public. In fact, Truett Cathy requested, before his death, that his children honor his request to keep the company private.
Much like Hobby Lobby, Chick-fil-A operates under Christian principles, which explains why the chain is closed on Sundays and why its corporate purpose is aligned to its owners' religious beliefs and preferences.
Closely Held Corporation FAQs
What Is the Difference Between a Closely Held Corporation and an LLC?
Using the IRS rules on closely held corporations, most Limited Liability Corporations (LLCs) are considered closely held corporations when they function as partnerships; however, the rules for what constitutes a closely held corporation and an LLC vary per state. LLC owners are not personally responsible for the company's debts and liabilities, and profits and losses of the business pass through to the owner, much like income is passed to the shareholders of a closely held corporation.
Do Closely Held Corporations Pay Dividends?
Because issuing dividends results in double taxation, most closely held corporations do not pay dividends.
Can You Pass a Closely Held Corporation to Your Heirs?
A closely held corporation will be passed to the heirs of the principal, unless there is a will specifically transferring shares to others.
The Bottom Line
A closely held corporation is a company with the majority of its shares owned by a few individuals. Shares are not traded publicly on an exchange and, therefore, cannot be purchased by the public. Those who control most of the shares have a significant influence on and control of the company. However, closely held corporation shareholders do not receive the same preferential tax treatment as those of corporations with actively traded stocks.