As businesses are formed, their various business structures need to be decided upon. One such decision that needs to be made is whether the firm will be of limited or unlimited liability. Limited and unlimited liability are concerned with the obligations of the owners; whether their obligations are limited to the amount of funds invested, or whether they are held personally liable. The following article takes a closer look at the two forms of liability; unlimited and limited liability and highlights the differences between the two.
Limited Liability
Limited liability is when the liability of the investors or owners of a company is limited to the amount of money that they have contributed/invested in the business. The owners of a company that is registered as a limited liability company will be safer in the event that the firm faces bankruptcy. The meaning ‘limited liability’ is that the owner’s losses are limited to their specific share of contributions and cannot be held responsible for losses beyond their share of contribution. The most popular and well known form of a limited liability company is a corporation.
Owners in a corporation are shareholders, and the liability of shareholders are only limited to the amount of funds that they invested. If the company goes bankrupt, the shareholders will lose their entire investment in the firm but are usually not held liable for losses beyond their contribution. Alongside the advantages, there are also disadvantages of a limited liability company. Managers of a limited liability company are protected against personal liability (their personal assets cannot be seized to pay for losses), which may result in them acting in a reckless manner as they are protected against risk of loss.
Unlimited Liability
Unlimited liability is quite the opposite of limited liability, and the liability of the owners or investors are not limited to the amount that they have contributed. This means that there is no limit to the losses that might have to be borne by the investors or owners. For example, the company makes total losses of $100,000 the owner had invested $50,000 of this which will be lost immediately. Since the company has unlimited liability, the owner’s obligations to pay will not end with $50,000. He will have to dispose his personal property to recover the other $50,000.
However, there are benefits to investing in a company with unlimited liability. The popular phrase in financial management ‘higher the risk higher the return” is quite relevant for companies with unlimited liability. Since the risk of investment is higher, there is a possibility for a higher rate of return in the event that the company succeeds.
Limited vs Unlimited Liability
Limited and unlimited liability are both concerned with the obligations of the owners, whether their obligations are limited to the amount of funds invested, or whether their obligations go beyond their investment and extend up to their personal assets. Limited liability is safer for the owners of the corporation as their liability is limited to the share of the funds that they invested. However, for owners of companies with unlimited liability, there is no limit to the amount of losses that will have to be borne. Owners of a limited liability company are seen as investors or providers of funds for the company to use. Owners of an unlimited liability company are a part of the firm and are held personally responsible.
Summary:
Difference Between Limited and Unlimited Liability
• Limited and unlimited liability are concerned with the obligations of the owners; whether their obligations are limited to the amount of funds invested, or whether they are held personally liable.
• Limited liability is when the liability of the investors or owners of a company is limited to the amount of money that they have contributed/invested in the business.
• Unlimited liability is quite the opposite of limited liability, and the liability of the owners or investors are not limited to the amount that they have contributed. The owners of a company with unlimited liability can be held personally responsible to pay for the company’s losses.