Before we define unlimited liability, the need is to know the meaning of business liability. All kinds of businesses come with the factor of liability. It means the owners, shareholders, or members are responsible for the business debts. Liability can be of two types.
- Limited Liability
- Unlimited Liability
1- Limited liability means the owners are responsible for the business debts in a limited manner. The capital invested in the business will be used to clear the debts. If the business fails, owners’ assets are protected.
In other words, the liability is equal to the value of his shares. This factor makes the liability limited. Business structures that come under limited liability are partnership business and LLC.
2- Unlimited Liability is when the owner has total responsibility for business debts. Unlike limited companies, this kind of business structure does not provide security to personal assets. In case, the company fails. The owner has to pay business debts from personal possessions.
There is only a single individual to manage the business and enjoy the profits. There is no one around to dictate the business direction with the disadvantages of unlimited liability.
Case Study for Unlimited Liability:
If we assume Partner A and Partner B intend to invest in a business structure like Sole Traders or any other General Partnership Business based on mutual interests. They agree to pool in an amount of £20,000 each for business investment.
The business is also under the burden of a loan with an amount of £100,000. In case this type of business faces losses and fails to repay the loan. Both the partners are equally liable for the business debt.
In such a situation, the personal possessions and assets of the owners are not protected and can be seized by the banks. Also, if one of the partners does not own personal assets, the second partner will recover the loan of £100,000 from his assets.
If the business structure comes under the Limited Company or Partnership, the owners will be liable to pay only the initial invested amount of £20,000. This case is a loud and clear example of the benefits of Limited Liability Structures. The personal possessions of business owners are not seized by the banks to recover the debts, just the initially invested capital is at risk.
Unlimited Liability Implication:
Business structures with unlimited liability do not protect the personal assets of business owners. As a result, the assets of owners can be seized by the banks in the process of settling the financial obligations of the company.
The reason for unlimited responsibilities for the owners of a general partnership or sole tradership is that the corporation does not have separate legal existence apart from its owners. Here such business structures fail to attract people. As they lack in terms of having legal and independent existence. The firm and the owners are one existence that undergoes losses together.
Due to the mentioned facts, only small businesses with little finances are Sole Traders or general partnership. While this structure is easy to set up, it can be a risk to large businesses. Therefore, it is usually observed that when small businesses grow they tend to change their structure to limited liability companies.
Hybrid Structure and Capital Limits:
In a general partnership, business owners are considered to be liable, to an extent of their own share in the business. In such agreements, the partners are only responsible for their prorated share invested in the business.
Let’s assume three partners are managing one business entity based on mutual interests. In which they have invested £20,000 each. Now, the business entity owes £120,000 and is unable to repay. Each partner owns 33% shares of the company. They will be liable for £40,000 of the amount to repay the debts. If any of the partners are unable to repay, the bank can still get a maximum of £40,000 from each partner.
This hybrid structure offers protection to the personal assets of business owners. However, it is not very popular in the UK.
In Conclusion, there is no doubt that business structures with Unlimited Liability provide the best platform for beginners who intend to invest on a small scale to set up a small business. However, once the business grows to a large entity, it is time to reach out to a limited company structure to avoid any ugly circumstances in the life span of your business.
Get yourself registered as a Sole Trader with Accotax!