What’s it: Limited liability is a legal status where the owner’s liability is limited to the value of their investment in the company or partnership. The business’s obligations are not the owner’s responsibility as a person because the business is considered a separate entity from the owner.
So, if a company is sued, then the plaintiff is only entitled to claim the company’s assets, not the owner’s assets. Then, the owners only lose the money they invested in the company if the business goes bankrupt. Thus, they avoid personal bankruptcy and do not have to sell their assets or property to pay off the company’s debt.
Limited liability example
Some business organizations have limited liability, such as:
- A private limited company is a corporation where the owners have limited liability, and the shares are not sold to the public. So, when you invest in stocks, you will not find their shares traded on the stock exchange. Sometimes, we refer to them as closed companies or privately-held companies.
- A public limited company is the opposite of a private limited company. Indeed, the owner has limited liability, but the company’s shares are sold to the general public through the stock exchange. Called a public company or listed company.
- A limited partnership refers to a business organization formed by several parties, referred to as business partners, to achieve a common goal. Business partners are divided into two: general partners and limited partners. The general partner’s liability is unlimited. Whereas a limited partner’s liability is limited and usually only contributes to the investment capital and is not involved in the day-to-day operations.
- A Limited Liability Partnership (LLP) is a partnership in which each partner has limited liability. They are actively involved in managing and operating the business. Financial and legal errors by one partner are not the responsibility of the other partner.
- A limited liability limited partnership (LLLP) is similar to a limited liability partnership. It has general partners and limited partners. However, the general partner has some protection against liability, unlike in a limited partnership.
A business organization with limited liability is often contrasted with a sole proprietorship, in which the owners have unlimited liability. Under a sole proprietorship, one person is responsible for the business’s operations, profits, liabilities, and risks.
Another business organization with unlimited liability is a partnership. An example is a general partnership. Another example is some partners in limited partnerships, as I mentioned earlier.
Limited liability advantages
Organizational structure. Companies with limited liability usually have a more organized business structure. And they have more established resources than a partnership or sole proprietorship. Therefore, they have a better competitive capacity than the other two.
Debt. Owners personally are not so afraid if the business takes on debt to support business expansion. That’s because if the company goes bankrupt, they are not responsible for the company’s debt. They do not have to sell personal assets to help pay off outstanding debts or company obligations. So, their total wealth is not affected.
Risk transfer. The company’s greater risk of default is transferred from the owner to the creditor. For this reason, creditors are very interested in the performance and financial position of the company to see the ability to pay. They will not see how rich the owners are when they decide to lend to the company.
Separate entity. Limited liability companies are legally recognized as separate entities from their owners. So, if the company is sued, the owner has no legal obligation. They are not prosecuted, but only their company.
Continuity. If the owner or director dies or quits, it does not cause the company to cease operations or dissolve. The company’s operations are unaffected and continue to run.