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CLOSE CORPORATION




What Is a Close Corporation?

The easiest definition of a close corporation is one that is held by a limited number of shareholders and is not publicly traded. The company is run by the shareholders and is generally exempt from many requirements of other corporations, including having a board of directors and holding annual meetings. Close corporations are state-specific statutory entities usually created to relax corporate formalities in operation and to be less focused on taxation. Some states have no provisions for allowing close corporations.

Advantages and Disadvantages of Close Corporations

As with any type of business structure, there are upsides and downsides that owners should be aware of. Some of the advantages of close corporations include the following:

  • Liability limitations – While there are fewer corporate formalities required with close corporations, the shareholders do not face any personal liability for the debts of the corporation.
  • Operational flexibility – As there are fewer shareholders, and depending on how the shareholder agreements are written, there are far fewer reporting requirements.
  • SEC requirements – Unlike a publicly traded company, a close corporation has no obligation to submit information about issues that impact the company and require a vote by a certain date. In many cases, changes may be considered without the requirement of a meeting.
  • Lower costs of operation – There are fewer reporting requirements, making the overall cost of accounting, legal counsel, and administrative fees much more inexpensive and saving the company thousands of dollars annually.
  • Buyout of stock – The shareholder agreement will typically have clear directions for buying back stock for shareholders who are deceased, when a shareholder exits the corporation for any reason, or to handle stock transfers in the event of divorce. This is typically to avoid having outsiders become part of the company.
  • Intellectual property rights – In most cases, a close corporation has less risk when it comes to protecting its intellectual property because only those inside the corporation are aware of what processes, methods, or documents are used inside the company.

There are also downsides to this type of business structure, as follows:

  • Limited options for divesting shares – The shareholder agreement will contain specific restrictions on divesting shares. In most cases, to sell the corporate shares, the interested shareholder can only sell shares to current shareholders. This may put limitations on how much the shareholder can earn on the sale and limits the number of people who may purchase the shares. 
  • Limited options for capitalization – Unlike other business structures, the capital of a close corporation comes only from the owners of the corporation. This can be a serious limitation should the company wish to expand. Since there is no publicly traded stock, the owners cannot solicit funds from people other than the owners.
  • Close corporation taxation – Close corporations are taxed as a C corporation unless the owners and shareholders decide to seek S corporation status.  This means the income of the corporation may be subject to double taxation.


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