Key Takeaways

  • A closed corporation (also called a close corporation) in California is a statutory entity with no more than 35 shareholders, offering simplified governance and greater shareholder control.
  • Shareholders often manage the business directly, bypassing a traditional board of directors, and enjoy reduced corporate formalities.
  • Stock transfer restrictions, shareholder agreements, and limits on going public help maintain control and stability within a closed corporation.
  • While they offer flexibility and liability protection, closed corporations face challenges with capital raising, investor attraction, and share liquidity.
  • Alternatives like LLCs may provide similar benefits with fewer ownership restrictions, depending on the company’s goals.

What is a close corporation in California? Basically, a California close corporation is a type of statutory corporation that has been formed based on specific requirements in this state.

Basics of a California Close Corporation

Section 158 of the California Corporation Codes allows for the formation of close corporations. This section defines a close corporation as a corporation that does not have more than 35 shareholders, and that number of shares and shareholders of the corporation are specified in the Articles of Incorporation. The main purpose of forming a California close corporation is to give the shareholders of your company more control than they would have with a normal corporation.

Generally, the shareholders of a close corporation will act as the managers of the company. In addition to giving shareholders more control, forming a close corporation means not having to follow as many corporate formalities as normal corporations. This means that close corporations are less likely to have their corporate veil pierced and their owners' personal assets put at risk in a lawsuit.

For instance, Section 300 of the California Corporations Codes states that if a close corporation fails to hold shareholder or directors' meetings, shareholders will not be exposed to personal liability. That being said, the shareholders in a close corporation that handle management duties have the same financial responsibilities as the officers or directors of a normal corporation.

To form a statutory close corporation California, multiple requirements must be met:

  1. There can only be 35 shareholders in the close corporation. Corporations, spouses, partnerships, and trusts count as a single shareholder.
  2. The close corporation's Articles of Incorporation must include a provision that limits the amount of shareholders to the required number.
  3. The share certificates of the corporations must indicate that it is a close corporation and that there cannot be more than 35 shareholders.
  4. There must be a written agreement between the shareholders that outlines that the shareholders, not a board of directors, will manage the company. This agreement should be filed with the Secretary of State and needs to available to potential buyers.

Besides these basic requirements, statutory close corporations in California are not allowed to go public. This is related to the 35-shareholder limit. When a corporation goes public, limiting the number of shareholders is not permitted, making it impossible for a close corporation to also be a public corporation.

Although California close corporations cannot trade their stock publicly, they can place restrictions on stock ownership, which is one of the biggest benefits of this type of corporation. Essentially, close corporations are operated very similarly to a partnership. With both of these entities, the owners are very hands-on in regard to the daily operations.

Ownership, Structure, and Management

A closed corporation is designed for closely held businesses where ownership and control remain within a small group of individuals — often family members or business partners. Unlike traditional corporations with separate management and ownership layers, shareholders in a closed corporation frequently serve as officers, directors, and decision-makers simultaneously

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Key structural features include:

  • Shareholder Limits: California law caps the number of shareholders at 35. This allows for streamlined governance and direct involvement of owners in decision-making.
  • Transfer Restrictions: Shares are often subject to transfer restrictions to prevent outside parties from gaining control. These restrictions must be clearly stated on stock certificates and in the corporate bylaws.
  • Flexible Governance: A closed corporation may operate without a formal board of directors if shareholders agree to manage the company directly. This reduces bureaucratic overhead and speeds up decisions.
  • Custom Agreements: Shareholder agreements are vital in defining voting rights, profit distribution, buy-sell provisions, and dispute resolution processes. These agreements help maintain operational harmony and protect minority shareholders.

Closed corporations often resemble partnerships in terms of operational involvement and decision-making, while still benefiting from corporate protections such as limited liability.

Drawbacks of Close Corporations

It's common for small businesses to structure themselves as a statutory close corporation because they can be run very flexibly, and they also provide limited liability protections. You should keep in mind, however, that you can receive these same benefits with a limited liability company (LLC), without the need to restrict the owners of your business.

Since LLCs became available in California, fewer people have been motivated to choose the close corporation structure. The reason close corporations were once so popular is that they came with far fewer corporate formalities. For example, these corporations do not need to hold annual shareholder meetings, which is an important requirement for traditional corporations.

There are a variety of risks you may be exposing yourself to by picking a California close corporation as your business entity. For example, if your shareholders who serve as managers breach their financial duties, they can be potentially be held liable. Additionally, because of the strict shareholder requirements, it can be hard for a close corporation to attract investors.

It can be difficult to market the shares of a close corporation because of the difficulty in transferring them and the limited number available. With a close corporation, the need to follow corporate formalities is less strict. That being said, these formalities are still important for several reasons. For instance, by following corporate formalities and having documentation as such, your corporation may find it easier to get loans from banks or other lenders.

Taxation, Compliance, and Growth Considerations

While a closed corporation offers flexibility and control, it also introduces certain long-term challenges that entrepreneurs should consider before choosing this structure:

  • Taxation: Closed corporations are typically taxed as C corporations, meaning profits are taxed at the corporate level and again when distributed as dividends. Electing S corporation status may reduce this burden but adds eligibility requirements.
  • Growth Limitations: Because they cannot go public and must cap ownership, closed corporations have limited access to outside investment and capital markets. This can hinder expansion or strategic acquisitions.
  • Share Liquidity Issues: Shares are harder to sell due to transfer restrictions, which can complicate succession planning or shareholder exits.
  • Compliance Needs: Although formalities are relaxed, closed corporations must still meet state filing obligations, maintain records, and adhere to shareholder agreement terms to preserve liability protections.
  • Risk of Internal Disputes: Concentrated ownership can lead to conflicts among shareholders, especially if agreements are poorly drafted or silent on key governance issues.

Understanding these factors can help business owners decide whether a closed corporation’s benefits — such as tighter control and simpler management — outweigh the trade-offs in flexibility and scalability.

Frequently Asked Questions

  1. What is the difference between a closed corporation and a regular corporation?
    A closed corporation limits ownership to 35 shareholders and often allows them to manage the business directly, while a regular corporation typically has a board of directors and no shareholder cap.
  2. Can a closed corporation go public?
    No. Closed corporations are prohibited from going public because doing so would violate shareholder limit rules and introduce outside ownership.
  3. Are closed corporations taxed differently?
    By default, they are taxed as C corporations. However, they may elect S corporation status if they meet IRS eligibility criteria, potentially reducing tax burdens.
  4. How are shares transferred in a closed corporation?
    Share transfers are usually restricted to maintain control within the existing ownership group. Any sale must comply with the terms in the shareholder agreement.
  5. Is a closed corporation better than an LLC?
    It depends on your goals. Closed corporations offer more formal structure and shareholder protections, while LLCs provide flexibility, fewer ownership restrictions, and pass-through taxation.

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