Table of Contents Hide
- What is a Close Corporation?
- How Does a Close Corporation Operate?
- Statutory Close Corporation
- Close Corporation in California
- Pros and Cons of Close Corporation
- Close Corporation Vs. Private Company
- Characteristics of Close Corporation
- Bottom Line
Closed corporations, also known as privately held companies, family corporations, or incorporated partnerships are companies whose shares are held by a small group of individuals.
They are not publicly traded and the general public cannot invest in them. Most shares are held by managers, owners or even families.
Get to know more about a close corporation, as you read this article. It’s a whole different world, out there.
What is a Close Corporation?
A close corporation is a corporation whose shares are held by a small limited number of people and these individuals are closely related to the business.
They are more expensive to set up because they need a written shareholders’ agreement, which must be drafted by a legal agent, and must be eligible for close corporation status.
When it achieves this, it is entitled to carry out operations without the usual formalities required in the operation of standard corporations which includes having a board of directors and holding annual meetings.
Although close corporations exist, the laws of most countries do not allow close corporation status to be declared by personal service corporations. This means that you have to be sure, the laws in your country permits you to do so.
Furthermore, close corporation companies are not publicly traded. This means that people from the general public cannot make investments or buy shares in them.
Most of the shares are held by people closely related to the business like family members, friends, etc. So, when a shareholder passes on or has a desire to liquidate their shares, members of the family buy back the shares.
How Does a Close Corporation Operate?
In close corporations, the interest of minority shareholders is not well represented. The majority shareholders hold at least 50 percent of the shares while the rest are shared amongst the remaining shareholders.
This means that the management of the company makes all the decisions without consultation from the minority shareholders. More so, the minority shareholders are also not allowed to transfer or sell their shares without informing and getting approval from the majority shareholders.
In the event that a majority shareholder leaves a close corporation either because of ill health, death, or some other reason, their shares are being redistributed to other shareholders in accordance with the shareholders’ agreement. This shareholders’ agreement may contain strict restrictions on who is eligible to obtain shares from the majority shareholders shares.
In case of a dispute, the feasible way to solve it is according to what is stated in the shareholders’ agreement. If the disgruntled shareholder is not satisfied with the position of the shareholders’ agreement, they have the option of going to court but it only gets to this in extreme cases.
Statutory Close Corporation
A statutory close corporation can be defined as a special corporation with fewer than 50 shareholders. It is not as rigid as regular corporations. They have fewer regulations and do not have a board of directors or hold meetings annually.
If there is to be an annual meeting, it will hold only under the condition that one of the shareholders sends a written request at least 30 days before the planned date of the meeting.
This is not the case for regular corporations as they have regular general annual meetings and they are expected to have a board of directors and a chairman of that board.
A lot of processes are involved in setting up these annual meetings and they have to be followed religiously to avoid being sued by any of the stakeholders.
Now, statutory close corporations are no longer the go-to for business owners that want corporate flexibility.
They now go to become limited liability companies which could also be as a result of the fact that statutory close corporation is not legal in some countries. Regardless, statutory close corporations remain an entity choice and may be made use of.
Close Corporation in California
A California close corporation is a powerful tool and it is advised not to use it if you do not need it.
In California, the general corporate laws are applicable to almost all business corporations. Most of these laws are fair and they work out for a majority of the business corporations but sometimes do not work for others in certain situations.
In these situations, these business corporations can then make use of the close corporation as a tool to sort out their issues.
Below are a few situations that could arise and be sorted out with the application of a close corporation.
According to the general corporate laws, a California corporation with more than two shareholders must have at least three directors. While a corporation with one shareholder can have only one director.
If Mr. A, who owns all the outstanding shares of his corporation and is the sole director gives Mr. B and Miss C 5% each of the shares, this means that the corporation must now have at least three directors.
But if Mr. A does not want the other shareholders to be able to outvote him as the sole director, he can go ahead to make the corporation a close corporation and adopt a shareholders’ agreement that says that this company would have only one director which will be him.
This position can only be changed if Mr. A resigns or dies or his shareholdings are reduced to 50% or less of the outstanding shares.
Dora, Chelsea, and Brad feel that having shareholders elect directors, and directors elect and supervise officers is too hierarchical for their free spirits.
So they elect their corporation to close corporation status (Close corporation status is elected by including a statement to that effect in the articles of incorporation) and provide in their shareholders’ agreement that the company will have no directors or officers and no board of directors.
Instead, the shareholders will be referred to as creative officers and they will make all the decisions affecting their company collectively.
A close corporation allows them to do this, but they will encounter obstacles in completing their statements of information and other documents that require regular officers.
In addition, they will encounter issues when they apply for officers’ and directors’ liability insurance.
In general, they would be performing the functions of directors and officers without getting the benefits of those positions.
Pros and Cons of Close Corporation
One has to carefully examine the advantages and disadvantages of closed corporation before deciding to make your business a closed corporation.
Pros of a Close Corporation
Below are the benefits of a close corporation.
#1. There is freedom of management
The business owners are free to run the company the way they deem fit because they do not have to comply with the general corporate regulations.
They are free to do so many things such as making decisions of donating to a charity without having to seek permission or approval from a board of directors.
They do things according to the shareholder agreement that they created themselves and it contains all the necessary regulations regarding these sorts of activities.
#2. There are fewer formalities
This may be seen as the most important advantage of close corporation. It removes many of the formalities that a standard corporation is supposed to follow.
There isn’t any need to hold annual meetings because the shareholders are already actively involved in the day-to-day running of the business.
Also, there isn’t any need to have a board of directors because the majority shareholder is in charge of taking major decisions.
#3. Limited Liability
In a closed corporation, the shareholders are not individually responsible for the companies’ debts. One of the few exceptions can be when a shareholder signs a document stating that he will be personally liable for the companies’ debts.
The shareholders of a close corporation have the power to ask certain owners to leave. The sale and purchase of shares in a close corporation are under the control of the shareholders. They decide who is qualified to purchase shares in their corporation and who isn’t.
Cons of a Close Corporation
Despite its numerous benefits, a close corporation still has some downsides. Let’s look at a couple of them below.
The fact that shareholders have more control may sound like it is a positive thing but it comes with more responsibility for the stakeholders. They manage the business and are somehow responsible for the actions and inactions of the company.
Depending on the laws of the state, your corporation could be taxed as a separate entity and this could lead to double taxation.
#3. The Financial Implication
In many countries, close corporations are still seen and treated as C corporations. They simply pass as a close corporation because of the number of shareholders they have.
That means the costs of incorporation are almost equal. They incur extra costs on the distribution of the shareholders’ agreement for negotiation and approval.
The market to sell the shares of a close corporation is usually very low or even in some cases, non-existent.
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Close Corporation Vs. Private Company
Both close corporations and private companies have limited liability of shareholders and they both can be referred to as legal entities.
A close corporation can have a maximum of 10 members while a Private Company can have up to 50 shareholders.
Private companies are required to hold general annual meetings while Close Corporation does not require an annual general meeting.
Private Companies comprise of Directors, while Close Corporation has only members.
In Private Companies, the Directors are responsible for the day to day running of the companies while in Close Corporation, the members are responsible for the day to day running of the company.
In Private Companies, other companies can buy shares and become shareholders while in Close Corporation, it is prohibited for other companies to be shareholders.
Private companies have a Memorandum of Incorporation while Close Corporation have a Founding Statement.
In Private Companies, it is compulsory for annual returns to be lodged while in Close Corporation, there is no annual return to be lodged.
Private Companies have audited financial statements in certain cases while in Close Corporation, no financial statement is needed.
Characteristics of Close Corporation
Below are the major features of a close corporation.
- A close corporation is subject to the Close Corporation Act 69 of 1984 and the Companies Act 71 of 2008. Under the new Act, Close Corporations are treated a lot more like companies.
- A memorandum of incorporation is not required, but a founding statement (K1 no longer in use because they are no new registrations) signed by, or on behalf of every prospective member used to be lodged with the Registrar. Amended founding statement CK2 still in use.
- Members of the CC both own and control the business
- All members of Close Corporation may take part in the management of the company.
- A close corporation is subjected to double taxation like companies.
- A close corporation is a separate entity that exists differently from its members so they are not liable in their personal capacity.
- The name of a close corporation company must end with the suffix CC.
- Two or more members are usually required to sign legal documents.
- Members do not have shares but interests expressed as percentages, and they cannot dispose of their interests without approval from other members.
- The “Business Rescue” clause also applies to a Close Corporation.
- All the information of a close corporation is available to its members.
- The life span of a close corporation is infinite. It is not influenced by the withdrawal, resignation, or death of a member.
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Depending on your business needs, a close corporation can either be a good or bad option for you. Regardless, i hope this article gives you basic knowledge on what a close corporation really is.
All the best.