A close corporation is defined as a corporation that is owned by a limited number of stockholders. Laws governing close corporation requirements vary from state to state, but most laws limit close corporations to only 35 shareholders. Close corporations are often comprised of family members or friends, and the members are usually relatively active in the day-to-day affairs of the business.
Most state laws allow close corporations to operate less formally than other types of corporations. For example, close corporation members occasionally can make decisions without needing to have a formal meeting with the board of directors. However, in order to enjoy the benefits that come with close corporation status, the organization must follow all of the requirements for closed corporation formation in the state that the corporation is incorporating in.
Finally, the treatment of stocks is different in a close corporation than in a regular corporation. Due to shareholder agreements that are frequently present among shareholders of close corporations, shareholders usually have much more control over how stocks are bought, sold, or resold. Also, close corporations are typically prohibited from making public offerings of their stock.
There are many pros and cons associated with close corporations. Of course, depending on your needs, the unique characteristics of a close corporation can either assist you or hinder you in achieving your business goals. A simple summary of a close corporation is that it combines the liability and debt protection of regular corporations with a more relaxed and informal flow of governance mechanisms.
Advantages of a Close Corporation:
- Fewer Formalities Than Regular Corporations: Governance requirements are usually relaxed in close corporations. For example, many states do not require formal or annual meetings. Also, the decisions of shareholders are often allowed to override the decisions made by the directors, thus changing the management dynamic of a typical corporation.
- Increased Control Over Shares: Typically, the shareholders will draft a collective agreement addressing buy/sell conditions for shares. The agreement usually bestows the shareholders with first rights of refusal on sales and transfers. Thus, control of the close corporation is held solidly within insiders.
- Less Complex Formation: Close corporations are generally less complex to form. They require fewer formalities, which means that there is less of a chance of error being made in the formation process. Additionally, closed corporations tend to be less complicated and less costly to maintain in the long run.
Disadvantages of Close Corporations:
- Increased Liability for Shareholders: Some states require that shareholders also be treated as if they were directors. Because the shareholders can be more active in a close corporation, this means that they are also exposed to more liabilities. For example, they could be held responsible for decisions made on behalf of the company.
- No Public Sales of Stock: Close corporations are not allowed to offer their shares of stock to the public. This can limit public exposure and marketing capabilities for the corporation, as well as resale potential for the stocks.
- Shareholder Decision-making Processes: Some shareholder decisions must be unanimous within close corporations, such as when deciding whether to terminate the corporation. Also, written shareholder agreements and bylaws are often required in order to allow the corporation to have closed corporation status, which can be complex and must be written by an attorney.
- Initial Costs: Although in the long run they may be cheaper to maintain, close corporations do involve a fair amount of start-up costs, especially when compared to other business options such as a sole proprietorship or limited partnership.
Before you decide to file for close corporation status, you should review the various features and limitations associated with this type of business structure. Also, be sure to review your state’s laws and requirements on close corporations, since they can differ widely by jurisdiction. Some states do not allow close corporations, though you can always incorporate in a different state if you are qualified to do so.
In any close corporation, the central focus will usually be on the shareholder agreement, which gives the shareholders the power to sell stocks or restrict stock sales. These can often be quite complex because they must reflect the overall goal of the organization while considering the shareholders’ backgrounds. It is in your best interest to contact a business lawyer to draft and review your close corporation’s documents, including the bylaws and articles of incorporation.