Key Takeaways

  • A closely held corporation is typically privately owned by a small group, often family or key individuals.
  • The closely held stock definition refers to shares that are not widely traded and are held by a few shareholders.
  • These corporations enjoy benefits like privacy, stability, and control but face limitations like reduced liquidity and valuation challenges.
  • Shareholder agreements often include buy-sell agreements and restrictions on transfer to maintain control.
  • Tax implications and succession planning are crucial for owners of closely held stock.
  • Charitable giving using closely held stock can offer strategic tax advantages.

A closely held corporation, also known as a closed corporation, is any company with a limited number of shareholders. While the company's stock may be publicly traded at times, this isn't a regular occurrence.

Closely held corporations tend to share the following characteristics:

  • They're small corporations with a small number of shareholders.
  • They may be either an S corporation or a C corporation.
  • State law dictates they limit the number of stock shares.
  • In most cases, they're run by family members.
  • They often have a more informal business structure, so some decisions don't require approval from the board of directors.
  • The shareholders are in control of operating the company.
  • The shareholders' agreement outlines how business decisions are made as well as places restrictions on the sale of stock.

About Closely Held Corporations

In the U.S., over 90 percent of all companies are closely held. A closely held corporation differs from many publicly traded firms, where the ownership is widely disbursed and professional managers often run the business.

In a closely held business, ownership may include traditional investors, but it may also involve family members. Many large, publicly traded businesses are controlled by families.

Families keep their hold on the business by doing the following:

  • Holding seats on the board
  • Holding positions in senior management
  • Having preferential voting privileges

Family members may remain dominant with these actions, although their shareholdings may be less than 50 percent. To qualify as a closely held corporation, people outside of the company must hold a minimum number of shares, such as members of the public at large.

By definition, a closely held corporation is a private corporation, but not all private corporations are closely held. They're different from privately owned companies that may issue stock but aren't publicly traded. Many closely held corporations are on the small side, but some are rather large.

If a shareholder in a closely held corporation wishes to sell his or her shares, one of the other shareholders must purchase them because public sales of shares aren't allowed. Many transactions between a closely held corporation and major shareholders don't get the type of special tax treatment that a corporation with actively traded stocks receives. For parties in these transactions, losses and deductions might not be allowed in some cases.

Individuals with shares in closely held corporations should consider consulting a financial planner who's experienced in the tax and estate ramifications associated with this type of stock.

A closely held corporation doesn't have to publicly disclose its financial information. It can also keep its records private because the Securities and Exchange Commission doesn't regulate it.

Advantages and Disadvantages of Closely Held Corporations

Closely held corporations offer both benefits and limitations, depending on business goals and ownership needs:

Advantages:

  • Control and Decision-Making: Founders and family members can maintain greater control without needing to appease external investors.
  • Operational Flexibility: Fewer shareholders mean quicker decisions without the need for shareholder votes or public disclosures.
  • Privacy: Financial information can remain confidential since SEC disclosure is not required for private companies.
  • Long-Term Vision: These corporations can prioritize sustainable growth over short-term stock performance.

Disadvantages:

  • Liquidity Limitations: Shares cannot be easily sold or transferred, potentially complicating exit strategies for shareholders.
  • Valuation Complexity: Without a public market, determining fair market value for shares can be difficult and often requires independent appraisal.
  • Raising Capital: Limited access to public markets may hinder large-scale fundraising, requiring reliance on private investors or debt financing.
  • Succession Risks: Family-run or closely held businesses must carefully plan leadership transitions to ensure continuity.

Defining Closely Held Stock

The term closely held stock refers to shares of a corporation that are not available on public stock exchanges and are held by a limited number of individuals, often founders, family members, or a tight-knit group of investors. These stocks are not freely traded in the public market, making ownership more concentrated and control centralized.

In most cases, closely held stock is not subject to the same market forces as publicly traded stock. This means that while it may offer enhanced privacy and stability, it can also be harder to value and sell. The closely held stock definition is commonly applied to shares in private corporations, where legal agreements often govern transferability to preserve the original ownership structure.

Other Points

Controlling shareholders

Usually, a small number of shareholders controls a closely held company, and these shareholders hold the majority of shares. Shareholders tend to maintain their investments over a long period of time, so new investors have little opportunity to obtain a large enough stake in the business to become a controlling member. Typically, only minority stakes are available for trade.

Hostile takeovers

Because majority shareholders usually hold onto their shares for the long term, it's hard for outside entities or corporations to attempt a hostile takeover. This gives the company a sense of stability since business decisions are made solely to serve the business.

Share prices

In addition, share prices in closely held corporations are often more stable because shares are rarely traded on the open market. Irrational market activity has little influence on stock prices in a closely held company. While this may make it harder to raise capital through the sale of stock shares, it also keeps the business from being subject to the whims of unpredictable investors.

These corporations may choose to raise capital through other means, such as by private funders — or venture capitalists — who buy shares in exchange for an infusion of funds. Closely held companies may also raise capital using their own operations.

While it may seem that most corporations are large, sprawling enterprises, the opposite is actually true. Many corporations are small companies largely controlled by family members. In most of these instances, the controlling parties have the best interests of the corporation in mind.

Charitable Giving Using Closely Held Stock

Closely held stock can be donated to qualified nonprofits, including universities or charities, offering donors potential tax advantages. While not as straightforward as donating publicly traded stock, closely held stock gifts may:

  • Help donors reduce capital gains taxes
  • Offer charitable deductions at fair market value if IRS guidelines are met
  • Require professional valuation and board approval from the receiving organization

This strategy is especially attractive for high-net-worth individuals seeking philanthropic impact while optimizing tax outcomes.

Tax and Succession Considerations

Closely held corporations often face unique tax and estate planning concerns. Shareholders may benefit from working with legal and financial professionals to address:

  • Estate Tax Exposure: Significant ownership in a closely held business can create liquidity issues for heirs. Strategies such as irrevocable life insurance trusts or gifting shares may mitigate estate tax burdens.
  • Business Continuity: Succession planning is essential to avoid disruption when a key shareholder exits or passes away. This might involve:
    • Establishing a family trust
    • Drafting a clear leadership transition plan
    • Utilizing stock redemption or cross-purchase agreements

Business owners should regularly revisit these plans, especially in family-run businesses, to account for changing dynamics.

Legal Agreements and Restrictions on Transfer

In closely held corporations, shareholders often establish buy-sell agreements or shareholder agreements that govern what happens if an owner wants to sell or transfer their shares. These agreements may:

  • Require that shares be offered first to existing shareholders or the corporation itself before being sold to outsiders.
  • Outline valuation methods for shares (e.g., book value, formula-based, or third-party appraisal).
  • Impose restrictions to preserve family ownership or prevent hostile takeovers.

These provisions help maintain control and avoid external interference that could disrupt the closely held structure.

Frequently Asked Questions

1. What is the closely held stock definition? Closely held stock refers to shares of a private corporation owned by a small number of individuals, typically not traded on public stock exchanges.

2. Can I sell closely held stock freely? No. Closely held stock is usually subject to restrictions in shareholder agreements, requiring existing owners or the company to have the first right to purchase.

3. How is closely held stock valued? Valuation often involves professional appraisals considering factors like earnings, assets, and comparable company performance since there’s no public market price.

4. What are the tax implications of owning closely held stock? Owners may face challenges with estate taxes and capital gains. Proper planning, including trusts or structured buyouts, is essential to mitigate tax burdens.

5. Can I donate closely held stock to charity? Yes, but it typically requires a professional valuation and the recipient’s willingness to accept non-liquid assets. Tax deductions and capital gains savings may apply.

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