Overview of Closely Held Business Law

With a small number of owners and shares that are not publicly traded, closely held businesses operate differently from public corporations and face a distinct set of legal challenges. Governance and control often depend on shareholder agreements that outline fiduciary duties, restrictions on transfer of shares, and how disputes will be resolved.

But even with those safeguards, conflicts can arise. Disagreements over valuation, shareholder rights, or succession planning can put the future of the business at risk. By understanding these issues in advance, owners can take steps to prevent shareholder disputes and protect long-term stability. For personalized legal advice, consult with a closely held business lawyer.

What Is a Closely Held Business?

In a closely held business organization, the majority of the shares are held by only a small number of people. The Internal Revenue Service (IRS) requires the majority shares to be held by five people at most, which seems restrictive, but the vast majority of small businesses in America are considered closely held.

These businesses are often family businesses formed under an LLC or partnership. The family members usually have a shareholder agreement that describes how decisions are made and outlines any restrictions placed on stock ownership.

Shareholders operate the business, and the businesses tend to have a more informal operating structure. Given the small number of shareholders to begin with, majority shareholders can exercise a lot of influence over business decisions. This structure allows decisions to be made without the approval of the board, which can speed up some processes.

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Benefits and Drawbacks of Closely Held Businesses

The main benefit of keeping your business closely held is that you will be able to retain control of the majority of shares. This helps keep decision-making powers contained. Business owners will also be protected from liability in many cases because of the nature of incorporation.

Additionally, many states have passed legislation that creates benefits for closely held businesses, which sometimes means these businesses don’t have to file certain forms as often or at all. Your business may also qualify for S corporation status, which offers tax benefits.

Unless you elect to be taxed as an S corporation, your business will likely be taxed as a C corporation, which can lead to double taxation. It can also be difficult to sell shares in a closely held corporation since these shares are generally not publicly traded, and because the majority of shares are required to belong to a small number of people.

While subject to less paperwork, closely held businesses can be required to follow more complex tax rules and may face more scrutiny to ensure the benefits are only going to corporations operating within the requirements.

Key Legal Documents for a Closely Held Business

Owning and operating a business comes with legal responsibilities. Addressing them upfront during formation reduces the potential for legal issues to arise later.

The first legal documents needed are for the formation of the business entity. These are required for limited liability companies, S corporations, and C corporations. In addition, the owners should create a shareholder agreement that define roles, responsibilities, and the decision-making process.

Outline the procedure for buying and selling shares. Before the company hires employees, documents should be created to define roles and responsibilities for each employee. This includes who has managerial oversight responsibilities for those employees.

No one wants to think about the business ending or them no longer being a part of it during the formation phase. However, long-term planning is a must to ensure the security and continuity of the business. Succession planning documents protect the business and its shareholders.

The succession could be outlined in estate planning documents, such as a will or trust. It could also include protective documents, such as non-compete and confidentiality agreements for those who leave the business. These documents prevent former owners or employees from using intellectual property or professional contacts to start a competing business. A valuation agreement reduces the risk of dispute when the business changes ownership.

Common Disputes and How To Resolve Them

When multiple individuals own and operate a business together, there are bound to be disputes. Understanding the most common types of disputes can help shareholders be prepared and resolve them quickly.

How to manage the business is a source of common conflict. Majority and minority shareholders may have different opinions about how to run the business. Sometimes, these disagreements focus on the overall direction of the company. Other times, it can be about daily management, including employee promotion, termination, or salary decisions.

Sometimes, disputes can lead to a deadlock situation, where shareholders/owners with equal power cannot come to an agreement. Disputes can arise when changing the business. Valuation disputes often arise during mergers, shareholder buyouts, or the bringing in of a new shareholder.

If a dispute arises, there are several methods available for resolution. Negotiation and mediation bring in the assistance of an outside third party to resolve the issue. Having someone mediate can help preserve the business relationship. If the issue is more serious, arbitration can help find a resolution faster and more affordably than litigation.

If disputes can’t be resolved, litigation may be the only and final option. It may also be necessary if the dispute involves a breach of duty, fraud, or shareholder oppression. While not desirable, sometimes a dispute can only be resolved through the dissolution of the business.

Many of these common disputes can be avoided with careful planning and preventative measures. This starts with crafting a detailed shareholder agreement. Include provisions that address how to resolve disagreements. This could require mediation or arbitration. One of the most important is outlining how the business will be valued. Once the business is formed, open communication is a must. Operational transparency helps to reduce miscommunications and incorrect assumptions that lead to disputes.

Succession Planning for Your Business

A closely held company can be in a vulnerable position when one or more of the shareholders moves on from the business. This can happen because of retirement, voluntary exit, incapacity, or death.

Having a succession plan in place ensures the viability of the business by preventing disputes between the remaining shareholders. It also protects the business’s value. Without a plan in place, there could be a forced sale or disputes that drain financial resources.

While some business owners include their succession plan in their estate planning, this isn’t always the best strategy. While it can provide several tax breaks, it can result in miscommunication if the plan isn’t shared with everyone.

One option is to have a buy-sell agreement between the owners. It outlines what happens with each owner’s shares. Often, it gives the other shareholders the first right of refusal to buy the shares before being sold to someone outside of the company. In many situations, the current owners and leaders will identify a future leader. It could be a friend, current employee, or family member.

When creating a succession plan, it’s crucial to consider all possible legal complications. The succession plan needs to follow state corporate laws. It also needs to align with the shareholder agreement and employment contracts. Tax consequences can be more severe if the succession is not done carefully.

The Role of a Business Litigation Attorney

A lawyer can help you create a business plan and ensure you meet the requirements to be a closely held business. Your lawyer can help you understand your taxes and other filing requirements, and they can walk you through the process of selling shares. A lawyer can also help you understand whether your business is eligible for exceptions to some business regulations.

A lawyer will be able to anticipate potential problems with your business and advise you on how to approach them. Your lawyer will also keep track of deadlines and file all the paperwork with the necessary courts and agencies, giving you one less thing to worry about.

Protect Your Business with Legal Guidance

As a business owner, you need to be someone who can give you legal advice throughout your company’s lifespan. Visit the Super Lawyers directory to find a closely held business lawyer.