If you are starting or buying a small business, you may be wondering if a closely held corporation is the type of organizational form that you want your business to have. A corporation is a legal entity that is created under state law. It is directed by a group of people, called the board of directors, for a common purpose. It is owned by the shareholders.

A closely held corporation or close corporation is a corporation in which shares are held by one shareholder or a closely knit group of shareholders. The shares are held by a small number of people, and the shares are not traded on a public stock exchange. The majority shareholders participate in the management, direction and operations of the corporation.

Advantages

There are advantages to having a closely held corporation:

• Continuity of existence - The corporation does not end with the death of the shareholders.
• Limited liability - Shareholders are insulated from personal liability from the debts of the corporation.
• Extent of ownership participation in management - The extent of ownership management and control is versatile. It depends on the state law and the options chosen by the incorporators.

Disadvantages

There are some disadvantages to having a closely held corporation:

• Complexity - The corporate form is complex because of the laws and the documents involved.
• Transferability of interest - There are often restrictions placed on the transfer of shares either by state law or by agreement of the incorporators.
• Taxes - There will likely be two levels of taxation, with both the corporation and its officers and/or shareholders having liabilities for taxes on income derived from the corporation's activities.

Corporate Form

Most state laws governing corporations create a structure giving the board of directors the most important position. The board of directors manages the affairs of the corporation, subject to its duties of care, loyalty and disclosure to the shareholders of the corporation. The board of directors delegates the day-to-day operations of the corporation to the corporation's officers. Officers execute the policies of the board of directors. Shareholders have the power to elect and remove the directors and to approve or disapprove actions of the board of directors that affect the fundamental character of the corporation or of the securities held by the shareholders.

Close Corporations vs. Public Corporations

Closely held corporations do not operate in the same manner as public corporations. The differences arise primarily from the fact that, unlike public corporations, closely held corporations are usually managed by the same group of people who bear the ownership risk in the corporation.

The fundamental difference between the two kinds of corporations is one of numbers. Closely held corporations have a small number of shareholders and publicly held corporations have a large number of shareholders. This results in several consequences:

• In publicly held corporations, there is a gulf between ownership and management. On the other hand, in the close corporation, owners invest, in part, with the expectation that they will participate in the management of the corporation.
• The shares of publicly held corporations have a public market and can be easily sold. In the case of close corporations, however, there is no such market and it may be difficult to determine the value of the shares and to sell them.
• The shareholders of closely held companies usually invest in those companies with the expectation that they will actively participate in the operations of the business. As a result, there is an incentive to substitute minority veto for majority vote rules, increasing the possibility of deadlock in the event that the small group of shareholders will split into factions with different views about how the corporation should be run. Shareholders in publicly held corporations have no such expectation; theirs is an ''impersonal'' investment.

If you are interested in setting up a closely held corporation, you should contact a business lawyer in your area, and determine if this business form is right for you.

Questions for Your Attorney

• Who owns a closely held corporation?
• What are some advantages to having a closely held corporation?
• How are closely held corporations different from publicly held corporations?

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