Closely-Held Business Laws

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 What Is a Closely-Held Business?

A closely-held business is a business entity that is owned by a small group of people. They typically have a common interest in the company. For example, they might be family members owning a family business.

The most common form of a closely-held business is the close corporation. This is a type of corporation that is owned, or “closely-held,” by a smaller number of people than a standard corporation. However, other types of businesses can also be considered to be closely held entities as long as it has a limited number of owners. If it has issued stock, the stock is not publicly traded, or the shares that are publicly traded are limited in number..

The Internal Revenue Service (IRS) defines a closely held corporation as a corporation offering non-personal services; 50% of its outstanding stock is owned by up to only 5 people within the last six months of any tax year.

How Do Closely-Held Businesses Compare with Publicly Traded Corporations?

Closely-held corporations are often held out as being different from publicly-traded corporations, even though they perform similar functions and have a similar form. For example, formation of both types of business entities is similar. Both kinds of corporations could have the form of an S corporation, a C corporation or an LLC.

The main difference between a closely-held business and a publicly-traded corporation lies in the nature of their company stock. For public corporations, the shares are traded publicly on existing stock markets.

In contrast, shares for closely-held businesses are generally not traded publicly, although some limited number of them can be publicly traded. Ownership of them is not of interest to the public, and there is no widespread general interest in trading in the stock. The shares are exchanged among a small community of people who are well known to each other and possibly even related; again, they may be members of a family sharing ownership of a family business.

However, if a minimum number of shares in a closely held company are held by people who are not part of some inner ownership circle, but rather are members of the public at large, the company can qualify as a publicly-traded company. So a closely held company can also be a publicly traded company.

What Are Some Advantages of Closely-Held Businesses?

Closely-held businesses offer a variety of benefits and advantages. A person considering starting a business may wish to consult with a lawyer for advice on whether to set the business up as closely held.

Some advantages of closely-held businesses are the following:

  • Efficiency: Company decisions can be made more quickly in a closely-held business because of its smaller size. Communication amongst members can be swifter and more direct;
  • Control: Closely-held companies are often able to manage profits and losses with greater control, since they are not subject to fluctuations of public stock markets.
    There is less risk of a hostile take-over of closely held companies, because it would be practically impossible for someone outside of the existing ownership group to obtain a controlling interest by purchasing a majority of the outstanding shares;
  • Community Contributions: A closely-held business may be more stable and more likely to remain in a single location, even through economically challenging times This may serve to benefit the surrounding community;
  • Ability to Avoid Certain Government Regulations: The federal Religious Freedom Restoration Act allows for-profit closely held corporations to opt out of certain government mandates when compliance would violate its owners’ religious beliefs;
  • Worker Relations: Some people suppose that closely held companies often maintain more intimate worker-to-worker relationships. Also, workers may be less subject to layoffs, since the shareholders usually absorb the losses instead of passing them off to the workers. This is hardly guaranteed, however.

What Are Some of the Disadvantages?

One of the main disadvantages of closely-held companies is that personal interests can often influence company decisions. Decisions may be made on the basis of factors that are not business-related and this could affect the profitability of the company. This is not usually the case in public corporations, as business decisions are usually made objectively in an impersonal manner.

Still, this disadvantage should not be overstated. Even executives of closely held corporations are required by law to exercise great care when making decisions. They, too, have a fiduciary duty to act in the interest of the corporation and its shareholders as with any other corporation. This fiduciary duty means that they cannot make decisions for personal gain.

Factions can sometimes develop in a closely-held company, resulting in disputes that need to be resolved through court proceedings. In such cases, each conflicting party may need to be represented by their own attorney in order to reach a suitable agreement. Company lawyers usually cannot represent both parties from the same entity if the conflict is internal.

Another disadvantage is that smaller closely held companies may not have the same ability to expand that larger companies with publicly traded shares may have. If the company needs a large amount of capital to grow beyond the limits of its structure, the organization may have to adopt a new corporate form and restructure the business entity completely.

The fact that few or no shares may be traded on the open market can mean that It is challenging to value the company properly. The lack of publicly traded shares means that it is difficult to obtain the information needed for making valuation estimates.

A closely held corporation does not have the same opportunities to raise large amounts of capital for new investments and expansion by issuing new stock or new classes of stock, because its shares are not listed on a public exchange.

In addition, if shareholders should want to exit the business, they might encounter difficulties selling their shares. The pool of potential buyers is likely to be very limited. Also, the sale of shares by the existing shareholders is often restricted by shareholder agreements relating to transferring shares.

Although executives control the operations of the company and make the important decisions, they must still exercise great care in making those decisions. Board members, officers and executives all have a fiduciary duty to act in the interest of the corporation and its shareholders as with any other corporation. This fiduciary obligation prevents them from making decisions in which personal gain is the controlling factor.

Do I Need a Lawyer for Closely-Held Business Issues?

Although there are many advantages to forming a closely-held business, legal issues can still arise in connection with the company. A person or group of people might want to consult a corporate lawyer for help in giving full consideration to all of the options. The investors or founders might want to consider not only present circumstances but possible future plans for growth even if they are in the start-up phase of the company.

If problems or disputes have developed in an existing company, or if the company needs to readjust its corporate form, an experienced business lawyer can help. Negotiating problems when they develop can help avoid problems ballooning into bigger issues.

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