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. First, the owners can exercise a much higher level of control over the entity than would be the case if they owned only a small proportion of the shares. Second, and depending on the state in which a business is incorporated, it may be possible to take advantage of statutory close corporation rules, which involve less paperwork. A third advantage is that 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.