When choosing a structure for your business, or looking to expand and grow, you may hear the terms limited company, private limited company or public limited company. You may have heard of a limited liability company (LLC), which is an American company structure that does not exist in the UK. However, the principle of limited liability still applies to UK businesses. This article will explain what limited liability means by considering the following areas:
● What is limited liability?
● How does limited liability work?
● What is unlimited liability?
● What types of businesses have limited liability?
What is limited liability?
Limited liability is the name of a business structure that reduces the owner’s financial risk. If a business was to fail or end up owing more money than it was making, limited liability reduces the amount of money that the owner is personally responsible for. By reducing financial risk, this business structure provides a safety net for investors and owners. Let’s look at how this works in a business setting.
How does limited liability work?
If a business were to fail, then the owner or owners would only be responsible for a limited amount of the debt that the business owes. They would be limited to losing up to the value of their original investment, so would not have to risk their personal finances being seized to repay the company’s debt.
For example, let’s say you start your own limited company and put £15,000 into getting things off the ground. You may also have other investors, who put in smaller amounts such as £5,000 or £2,000 and end up being part-owners of the business too.
If the business was to fail later down the line, and ended up being £30,000 in debt, you would be liable for your original £15,000 investment, and the other owners would lose their £5,000 and £2,000 cash injections. The limited liability structure protects your personal money, so instead of going after your own finances, the business assets would be seized or liquidised to pay off the remaining £8,000 debt.
If you do not have enough assets then the company will be liquidated if it cannot pay its remaining debts. The company would cease trading and your authority as a director would be nullified and taken over by an insolvency practitioner who would manage the liquidation. Any businesses you owe can then go through a court process to be paid.
This is limited liability in practice. Suppose your company did not have limited liability for its owners, then in this situation. In that case, your personal savings and assets such as your house and car could be seized to pay off the remainder of the business debt. If you are not set up as a limited company, you’ll likely have unlimited liability for the business and its financial obligations.
What is unlimited liability?
Unlimited liability means that there is no limit to the amount of money that you would be responsible for should your business fail or fall into debt. This applies to businesses that are not set up as limited companies, such as sole traders and some partnerships.
If your business became bankrupt or the company was involved in a legal battle that required money from the business, the business would be described as insolvent. If you are the sole owner, you would then be fully liable (meaning you are fully responsible) for paying all debts back. Once all the company assets have been sold to pay off as much as possible, then you will have to dip into your own savings or sell your personal assets to pay off the rest of the debt.
Larger businesses are almost always set up with limited liability as this allows them to attract investors who have less liability, so investing is less of a risk to them. Since investors are often unwilling to risk their personal money as well as their initial investment amount, sole traders with unlimited liability may find it hard to gain independent investors.
If you are starting to set up your business and thinking about limited liability, you could talk to an accountant to decide which business structure would work best for you.
What types of businesses have limited liability?
Let’s look at what liability for finances looks like in different types of business.
Limited companies are set up so that the business’s finances are a completely separate entity from the owner’s personal finances. This means if the company had to be liquidated, you’d lose the value of your share in the business, but your personal assets would be protected from being seized to pay the business debt.
All limited companies must be created and registered through Companies House. You can find out more about how to set one up here.
Sole traders are the only owner and usually the person running the business. Although sole traders may have employees, as the sole owner, you have unlimited liability if the company goes into debt. Once the business assets have been liquidated to pay the debt, you would be solely responsible for the rest of the money, and your personal savings or assets can be used to repay the remaining money owed.
Some partnerships are run almost like a sole trader but with two people running the business, while others are set up as limited companies. In both circumstances, there will be a partnership agreement, which is a legal contract that sets out how finances and investment are managed.
If your partnership is not set up as a limited company then both parties have unlimited liability for any debt. However, if you are set up as a limited company with both parties as joint owners, then your personal finances are separated from the business and you’ll have limited liability in the case of insolvency to protect your personal money.
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