A Statutory Close Corporation (also known as “Close Corporation”) is a corporation that does not publicly trade stock and is formed under a special statute. This type of corporation is held by a limited number of shareholders. In some states, Close Corporations may have up to 50 shareholders, in others they must have fewer. Shareholders may run their corporation directly without oversight by a formal board of directors or the obligation to hold shareholder meetings, provided they have a shareholders’ agreement in place that eliminates those formalities.
Not all states recognize the Close Corporation as a valid entity. Where recognized, it is governed by the state’s business laws and regulations which vary from state to state, but it is exempt from some of the compliance formalities of a conventional corporation. States’ special law provisions that govern close corporations allow them to have only a limited number of shareholders (that number varies depending on the state). Typically, states require that specific language identifying the entity as a Statutory Close Corporation be included in the corporation’s formation documents such as the Articles of Incorporation or individual stock certificates.
While sometimes people refer to all privately held corporations that don’t publicly trade stock on the stock exchange as “close” or “closed corporations,” only those that qualify for and elect Statutory Close Corporation status enjoy official recognition from the state as a Close Corporations and the benefits of fewer compliance requirements.
In this article, I use the terms “Statutory Close Corporation” and “Close Corporation” interchangeably when referring to Statutory Close Corporations.
Advantages of a Close Corporation
Registering as a Close Corporation may be attractive to solo business owners, spouses who will be co-owners of a company, family-owned and operated businesses, and companies that will be owned by only a small number of individuals.
Generally, a corporation with as few shareholders as allowed in a Close Corporation will not need the same level of checks and balances as a larger or publicly traded corporation. That’s essentially why some states offer this status. This entity type makes it less cumbersome for entrepreneurs to launch and operate a small corporation.
With any business structure, pros and cons exist. Whether a Statutory Close Corporation election will benefit a business and its owners depends on the state’s rules and restrictions, the goals of the business owners, tax implications, and other factors.
Let’s break down the key benefits of forming a Close Corporation.
1. Lessened Risk of Non-Compliance
With fewer corporate compliance requirements to fulfill, there’s less chance that business owners will falter and miss important tasks and deadlines (such as sending notifications for meetings, holding meetings, recording meeting minutes, etc.). When a business has less to tackle to remain legally compliant, there’s less chance that something will slip through the cracks and pierce the corporate veil that protects business owners from being held personally liable for debts of the company.
2. Personal Liability Protection
Like the C Corporation and the Limited Liability Company (LLC), Close Corporations offer shareholders a degree of personal liability protection. Under most circumstances, business owners are not held responsible for the legal or financial debts of their company.
3. Operational and Management Flexibility
Shareholders may be deemed the directors of the corporation, so business owners do not have to answer to an appointed board of directors. A Close Corporation’s shareholders’ agreement establishes how the corporation will be run, the roles and responsibilities of shareholders, shareholder ownership percentages, etc. It will contain provisions that cover matters such as:
- Regulation of the management of the business and its affairs
- Rights of shareholders to dissolve the corporation
- Voting rights and requirements
- Designation of officers of the corporation
- Dividend or profit distribution details
- Rules for the transfer or divestiture of shares
- Dispute resolution procedures
- Consensus on matters such as allowing an officer to serve in multiple capacities, not having a board of directors, and forgoing annual meetings
4. Lower Compliance Costs
With fewer ongoing reporting and filing requirements, Close Corporations may have less compliance-related costs than most other corporations.
5. Intellectual Property Peace of Mind
Statutory Close Corporations have more control over who has access to their documentation, methods, processes, and systems because they have fewer shareholders. With fewer people required to be privy to their intellectual property, their trade secrets and other confidential information may be better protected than in a larger or publicly traded corporation.
Disadvantages of a Close Corporation
1. Growth and Expansion Limitations
Generally, shareholders face strict rules regarding whom they may sell or transfer their shares to. They may be limited to only passing shares to the corporation, existing shareholders, or family members. Also, some states allow Close Corporations to only issue one class of stock to their shareholders. Those restrictions can stand in the way of raising capital to fuel company growth.
In addition, some financial institutions and other lenders may only be willing to offer loans or financing to organizations that have a board of directors and observe strict corporate formalities. That also can impact the business’s ability to grow.
2. Potential Tax Downsides
Unless the shareholders of a Close Corporation seek S Corporation status from the IRS, the company will be taxed as a C Corporation (which comes with the double taxation of profits distributed as dividends). While a close corporation will meet the IRS’s S Corporation eligibility requirement of having 100 or fewer shareholders, it may not meet other criteria. For example, the IRS may view the Close Corporation as having two classes of stock if the corporation’s shareholders have agreed to distribute profits disproportionately to their shares of ownership.
3. Not Available Everywhere
Presently, only several states offer status as a Close Corporation. Therefore, depending on where business owners plan to operate their company, it may not be an available option for them.
Comparing the Different Entity Types
Close Corporation vs. C Corporation
A Statutory Close Corporation is a corporation that has filed an election or supplement for special status in its Articles of Incorporation or through an amendment to its entity formation documents. C Corporations may request corporation status if they meet the state’s eligibility requirements (no public stock options, a limited number of shareholders, etc.).
Both Close Corporations and C Corporations offer personal liability protection for business owners. Likewise, provided they meet IRS requirements, they may elect for S Corporation tax treatment (more on that below).
Unlike a regular C Corporation, a Statutory Close Corporation typically does not have to:
- Elect a board of directors
- Hold annual meetings
- Adopt Bylaws (provided operating and management provisions are set forth in the Close Corporation’s agreement between shareholders or in the Articles of Incorporation)
- Report to the SEC (publicly traded C Corporations must answer to the U.S. Securities and Exchange Commission)
Close Corporation vs. S Corporation
Both Statutory Close Corporation status and S Corporation (Subchapter S status) are special elective options for qualifying corporations. Close Corporation status is granted by the state. Subchapter S status, a tax-related election, is granted by the IRS.
Both Close Corporations and S Corporations experience limits on the number of shareholders they may have. Some states that offer the Close Corporation option impose a shareholder limit of 50, with others limiting ownership to fewer than 30 shareholders. The IRS allows S Corporations to have 100 or fewer shareholders.
Statutory Close Corporations, if they meet all the IRS’s eligibility criteria, may attain S Corporation status and be treated as a pass-through entity for income tax purposes.
Close Corporation vs. Limited Liability Company (LLC)
A Limited Liability Company (LLC) is formed by filing Articles of Organization. Like close corporations and C Corporations, LLCs may elect for S Corporation tax treatment if they meet the IRS’s criteria. Because Statutory Close Corporations are exempt from some of the usual corporate compliance formalities, they have similar compliance requirements to those of LLCs.
LLCs use a governance document called an LLC operating agreement, which covers many of the same topics as the shareholder agreements used by Statutory Close Corporations.
Forming a Statutory Close Corporation
States that offer this status have their own eligibility rules for the types of corporations that may elect treatment as a Statutory Close Corporation. For example, in Pennsylvania, nonstock corporations, registered corporations, professional corporations, and insurance corporations may be statutory close corporations.
As I mentioned earlier, there is a special election or supplement that business owners must make in their Articles of Incorporation to request status as a Statutory Close Corporation. Some states also require that the certificates of stock issued to shareholders reflect that the corporation is a closed corporation, documenting restrictions on the transfer of shares.
If an existing corporation wishes to become a Statutory Close Corporation, it may become one by filing Articles of Amendment or another filing as required by the state.
What’s Right for Your Business?
That is a question to thoroughly explore with the help of an attorney and an accountant or tax advisor who can help you weigh the upsides and downsides. There will be legal, administrative, operational, and financial implications to consider with any business entity, so it’s vital to understand how your decision will impact you and your company.
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