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What is a Closely Held Stock?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 07 August 2018
  • Copyright Protected:
    2003-2018
    Conjecture Corporation
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Closely held stock is any type of stock option in which the majority of the voting shares are in the possession of a single or small group of investors. This is different from stock options that are classified as widely held and are owned by a large number of investors. In some countries, stock that is publicly traded but is currently controlled by an owner or a few shareholders is considered to be closely held. In other countries, the stock must not be traded on public exchanges in order to qualify as closely held stock.

In the United States, the Internal Revenue Service (IRS) understands closely held stock to be majority shares that are in the possession of the owner of the business, or possibly the owner plus one or two investors. A phenomenon of this type may come about in an entrepreneur ownership situation, where an individual starts a new business, incorporates the business in compliance with national regulations, issues shares of stock, but retains the majority of those shares between the owner and a few investors. With this model, the shares may be privately traded at some point, but relatively few shares are ever out of the control of the business owner and the core group of investors.

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Other countries around the world expand the definition of closely held stock to include shares issued by publicly traded companies, but retained by a small group of investors, along with the business owner. In this model, a small number of shares of some type of stock, possibly common stock, are traded on exchanges, but never enough to make a significant impact on the controlling interest maintained by the core group of investors. This leads to situations in which trading on the stock is either flat, or so thin that the possibility of acquiring enough shares to generate a desirable return is somewhat unlikely.

There are some advantages to closely held stock. One has to do with safeguarding the business from the possibility of hostile takeovers. With the majority of the shares in the hands of a select few, the task of acquiring enough shares to gain a controlling interest is extremely difficult, if not impossible. The time and expense involved in attempting to entice enough of the core group of investors to sell their shares is often enough to discourage hostile takeover attempts, unless there are extenuating circumstances that cause the investors to wish to sever their ties to the business.

Another benefit of closely held stock has to do with making decisions regarding the corporation. With a relatively small group of investors, the ability to vote on important matters relevant to the future of the corporation is much simpler than attempting to include thousands of investors in the process. This can allow the business to submit issues to investors for consideration, and receive responses in a short period of time, a factor that can allow a business to move forward with relatively few delays.

At the same time, a company that is closely held by a small group of investors is limited to the vision and agendas of that small group. This can create a situation where the corporation is unable to take advantage of new opportunities, since those opportunities are not considered important by the few investors who control the majority of the stock. In the worst case scenario, this inability to move forward eventually causes the business to begin losing ground to competitors, and results in losses for the core group of investors who preferred to maintain the current status quo, rather than support the corporation in its growth efforts.

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