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Closed Corporation: Characteristics, Advantages, And Disadvantages
Last Updated on: October 17th, 2024
“A closed corporation is a company which does not raise funds from the public and instead operates with a small number of shareholders to ensure supreme control over its functioning. Unlike a publicly-traded company, closely held corporations do not have to observe strict corporate regulatory norms regarding business operations and data reporting. There are special rules that are set to govern such corporations.”
However, this was not all that you needed to know about a closed corporation. There is much more to know. In this article, we shall discuss everything there is to know about a closed corporation. So, without any more delay, let us begin.
Key Takeaways
- In simple words, closed corporations are those companies that function with a very small number of shareholders.
- The general public has no involvement in this corporation as it does not trade its stocks in the share market.
- Companies that are closed corporations do have to abide by strict rules and regulations about their operations or reporting of data as it may happen with all other public corporations. They operate according to the laws of a particular state.
Let’s Understand A Closed Corporation
When a company structures itself as a closed corporation, it gets the benefit of liability protection without having to dramatically change the ways of business operation. It may also offer the company much better flexibility in its operations. This is because they enjoy the freedom from all the reporting necessities or the pressure from the shareholders.
There are various other names by which you may call this structure. They may include the following:
- Privately held companies
- Close corporation
- Family corporation
- Private company
- Incorporated partnership
They may also be known as “unlisted”, “closely held”, or “unquoted” companies.
A closed corporation would not publicly trade its stocks on any stock exchange. Therefore, the general public may not be able to make investments in any such companies. The managers or the owners are the only owners of the shares of the company. Sometimes, even their family members can have a portion of the shares.
In case of the death of a shareholder, or liquidation of the shares, the remaining shareholders would be entitled to purchase those shares.
However, due to the involvement of very limited people who have ownership, and the lack of public trading, a closed corporation may have issues with liquidity. But, there is a built-in incentive treat to each of the shareholders, officers, or directors fairly.
Characteristics Of A Closed Corporation
One may form a closed corporation as per the acts and provisions of the state government. There, the rules that govern a closed corporation may vary from one state to the other. When the business meets all of the requirements, it would be required to officially receive the “close corporation” status in order to enjoy all the benefits that flow from its very nature.
Let us now discuss some of its characteristics in absolute detail.
- For beginners, a closed corporation will not be publicly trading its stocks in any of the stock exchanges. Therefore, the general public will not take part in any of the operations of the business.
- Only a very small group of people would be able to procure the shares of the company. The number should not go beyond 36.
- Other than filing the corporate required documents, all other corporate regulations are pretty flexible for these companies. This is especially true when it comes to reporting the performance data.
- There are only very few people that constitute the management of a closed corporation. There can only be a maximum of five directors. This makes the running of the business seamless. Many of these individuals are shareholders.
Advantages Of A Closed Corporation
There are multiple benefits that businessmen get from owning a closed corporation. These advantages may include:
Lesser Formalities
In a closed corporation, the executives get a lot more time in planning for the business than spending time over the stern corporate guidelines. There are very few documents that they need to fill out, like the incorporation documents. With very few obligations to meet, like preparing the annual reports or setting up annual meetings, they can easily save the cost of arranging them. Furthermore, the management can thus focus on the important roles.
Better Management
A closed corporation enjoys a lot of flexibility in its operations because there are no shareholders to interfere as may happen with a typical corporation. Because of only a few members, decision-making becomes pretty easy.
Reducing Shareholder Liability
When the pressure to follow corporate formalities reduces, the liability on shareholders about any discrepancy in following the corporate rules also lessens. Moreover, in some private companies, the shareholders do not have the burden of debt liabilities either. In simple words, closed corporation rules play a major part in deciding the roles and responsibilities of the members. A freedom of this kind is not there in regular corporations.
Disadvantages Of Closed Corporations
While you may think that a closed corporation is the best way to conduct business, you may be wrong. There are drawbacks of a closed corporation as well.
Limited Qualifying Corporation
Not many states in America allow people to have a closed corporation. Some of the states in the US that recognize statutory close corporations are Arizona, Alabama, and Texas among others. All the private companies that are not under these states will hardly be able to get the authorization.
Limited Trading Of Shares
Selling the shares becomes a tougher job as, in multiple cases, the existing shareholders would have to purchase them. The seller has to struggle enough to be able to find a buyer, which in turn compromises the amount they receive after the sale.
Not For The General Public
Not being able to publicly raise money by selling the stocks creates a different set of challenges for a closed corporation. Whenever there is a crisis, the business has to look for other financial substitutes.
Increase In Responsibility
Because of an overlap in the responsibilities of the managers and owners, the responsibilities of shareholders increase in a closed corporation. Other than that, the minority shareholders will have a lesser say in comparison to the majority shareholders.
The Bottom Line
The concept of a closed corporation is indeed a well-sorted business structure. It does not involve the general public and has a smooth management. It also has more flexibility in its operations and has fewer regulations to abide by.
However, not every state in the United States allows for a closed corporation. And in times of crisis, these businesses struggle a lot to find substitutes for the money raised from the public.
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