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The “Close” in Close Corporation should be thought of as an abbreviation for “Closely Held Corporation.”
Close Corporations are often operated by a single person or a small, tight-knit group, such as a family, and cannot have more than 30 shareholders. The Delaware Close Corporation is an often-misunderstood entity type. Some people refer to it as a “Closed” Corporation, which is not accurate. Other people refer to it as a C Corporation, which it can be, but a General Corporation can also be a C Corporation. (The "C" does not stand for "Close.")
A General Corporation can have as many shareholders as it sees fit. With a Close Corporation, there are restrictions on the sale or transfer of stock. The sale or transfer of stock in a Close Corporation can be restricted by the Right of First Refusal clause.
Let’s look at an example in order to clarify.
Johnny, Larry and Sally form a Close Corporation. They authorize 3,000 shares and distribute them amongst themselves, equally.
After some time, Larry decides he wants to leave the company; in addition, he would like to sell his 1,000 shares to his friend Tony, who agrees to purchase them.
The Right of First Refusal clause can explicitly state that Larry cannot sell his shares to Tony unless Johnny and Sally agree they do not want the shares; they must also be in agreement that Tony is permitted to purchase the shares. If either circumstance is not agreed upon by Johnny and Sally, then Tony cannot be issued the shares.
These types of situational agreements illustrate why it is typical for family-run businesses to form a Close Corporation. A General Corporation does not include a Right of First Refusal clause.
In this same example, had it been a General Corporation the three friends had formed, Johnny and Sally would not have had a say in whether or not Tony could purchase the shares from Larry.
If it were a General Corporation, Larry could have split up his shares and sold them to 1,000 different investors if he had wanted to do so.
Typically, most people who are looking to raise funds and attract investors will choose General Corporation as their business entity type.
However, when it comes to small, tight-knit groups, families or single-person businesses, the Close Corporation can often be the logical, strategic choice.
The Close Corporation, like the General Corporation, can elect to file for Subchapter S tax status by filing IRS Form 2553 in a timely manner (and if it has met all the other qualifications).
The individual shareholders must be United States residents. This filing allows the Close Corporation to enjoy pass-through taxation, similar to that of an LLC.
When it comes to Delaware Franchise Taxes, General and Close Corporations are taxed in the same manner. Minimum stock General and Close Corporations pay $225 for the Franchise Tax and Report, while maximum stock General or Close Corporations pay a minimum of $450 for the Franchise Tax and Report, but this amount can increase based on the issued shares as well as the company’s gross assets.
If you have additional questions on forming a Close Corporation, General Corporation, LLC or any other type of Delaware business entity, please call Harvard Business Services, Inc. at 1-800-345-2677 or email email@example.com.
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.