What is a Closely Held Corporation?

A closely held corporation is a company whose shares are mostly held by a small group of investors. Family owned businesses are usually considered to be closely held, and are commonly managed by family members. The shares of such an entity are not usually publicly traded.

The IRS defines a closely held corporation as one in which five or fewer investors own at least half of all outstanding shares at any point during the last half of the tax year, and which is not a personal service corporation. Examples of personal services are accounting, consulting, and the practice of law.

Advantages of a Closely Held Corporation

There are several advantages to owning a closely held corporation, which are as follows:

Increased control. Owners usually have a more direct say in the management and operations of the business, avoiding the complexities of large shareholder structures. This can also result in quicker and more efficient decision-making.
More privacy. Closely held corporations are typically not subject to the same stringent disclosure and reporting requirements as publicly traded companies. This means that business strategies, financial performance, and shareholder identities can often be kept private.
Longer-term focus. Shareholders are typically invested for the long-term, leading to decisions that focus on sustainable growth rather than short-term market pressures.
Close-knit ownership. Shareholders often have personal or professional relationships, leading to better communication and mutual trust. This means that disputes can often be resolved informally without resorting to public litigation.
Minimal shareholder pressure. A small group of shareholders means less pressure to issue dividends or make decisions that cater to a broad, diverse investor base.
Earnings are retained. A closely held company can reinvest earnings without facing the same external pressures to distribute profits as dividends.
S corporation status. the owners can elect to shift the organization into S corporation status, where all income is passed through to the owners for tax reporting purposes; this means that the corporation does not pay federal income taxes.

How to Value a Closely Held Corporation

It can be difficult to obtain a valuation of the shares of this type of entity, since there are so few sales of the shares from which a price can be inferred. An alternative approach is to derive the present value of its cash flows, and divide this amount by the number of shares outstanding, on the premise that cash flow per share is a key basis on which investors set a value on a business.