What’s it: Unlimited liability means the owner is fully legally responsible for the business’s debts. Thus, creditors can ask the owner’s personal assets to pay off debts if the business experiences cash flow problems and cannot fulfill its obligations. Therefore, it places a business risk on its owner.
Unlimited liability is the opposite of limited liability. The latter considers the owner and the business as legally separate entities. Thus, the owner is not responsible for business debts. Their risks are limited to how much money they invest in the business.
Organizations with unlimited liability are less popular because they place the debt burden on owners when the company faces liquidation. They are usually only for small businesses with a limited operating scale.
Examples of unlimited liability
Two examples of unlimited liability are:
- Sole proprietorship
- Partnership
A sole proprietorship is owned and operated by one person. The owner may run the business as an individual, such as a graphic designer, copywriter, or electrician. Or they operate the business by recruiting several people as workers without the need to change the company structure.
A sole proprietorship allows the owner to have complete control over the business. Likewise, business assets are 100% privately owned by the owner.
Then, under a sole proprietorship, the owner is fully responsible for the business, including the business’s debts. Businesses and owners are not considered legally separate entities. Thus, if the company defaults on the debt, the owner is responsible for paying it off, which may force him to sell personal assets.
Meanwhile, under the partnership, a business is owned and operated by more than one person. We call them partners. There are two partners in this business organization. They are:
- General Partner
- Limited partner
General partners are actively involved in day-to-day operations and making business decisions. Meanwhile, limited partners do not manage daily operations and only contribute money and have limited liability, according to their investment.
Partnership arrangements can vary, some allowing partners limited liability. Examples are:
- General partnership (GP) is where partners share responsibilities, assets, and profits. They also share financial and legal obligations.
- Limited partnership (LP) is when two or more partners enter a business together. Still, this arrangement has a general partner with unlimited liability and limited partners.
- Limited Liability Partnership (LLP) which combines partnership and corporate elements. Each partner has limited liability and is not responsible for any other partner’s financial and legal misconduct.
- Limited liability limited partnership (LLLP) operates like a limited partnership. This organization has general partners and limited partners. But, unlike in a limited partnership, the general partner has liability protection and actively manages the business.
Unlimited liability pros and cons
An organization with unlimited liability usually has several advantages and disadvantages. Let’s use sole proprietorships and limited liability company partnerships as a comparison.
Limited liability companies have limited liability. They may be a private limited company or a public limited company. The latter sells its shares to the public through a public offering on the stock exchange, while the former does not.
Advantages of unlimited liability
Greater autonomy and flexibility for business owners are examples of the advantages of organizations with unlimited liability. Autonomy is absolute under a sole proprietorship. Business decisions are concentrated on the owner. Meanwhile, it is divided between the partners under the partnership.
Such autonomy is contrasted under a limited liability company. The owner is usually not involved in operating the business. Instead, they delegate it to other people, namely the directors. Thus, operations and business decisions are carried out by directors, not owners (shareholders). And directors may make decisions not in the owners’ best interests, even if appointed by them.
Other advantages of organizations with unlimited liability are:
Easy to set up and disassemble. Unlimited liability has no legal requirements for organizational and stewardship structures. For example, owners can stop a business and switch to another business whenever they want under a sole proprietorship.
All business profits belong to the owner. That’s 100% in a sole proprietorship. And under the partnership, it is shared between partners.
In contrast, in a limited liability company, the owner only gets dividends distributed by the company. The distribution is usually based on a certain percentage of the profits. But, sometimes, companies don’t pay dividends and keep their profits as internal capital (retained earnings).
Not obligated to disclose financial records. This is beneficial from a tax perspective. Owners may avoid taxes by keeping records of their business profits secret. In addition, keeping financial records confidential is also crucial in a competitive context because they are vital information.
Subject to fewer compliance regulations. Organizations with unlimited liability have more freedom around compliance and accounting regulations. The company is not obligated to release financial reports or publicly disclose how the business operates, changes in directorships, or new shares issued.
Disadvantages of unlimited liability
Unlimited liability exposes significant risks to owners. They can lose personal assets to pay off debts if a business fails. Thus, unforeseen circumstances or unfortunate mistakes can destroy personal finances.
Other drawbacks are:
Stress in running a business. Unlimited liability businesses often do not have specialties. The owner has to handle everything from finances to marketing to operations. They also have to make decisions in these areas.
Difficulty in obtaining funding. Banks generally prefer to deal with limited liability businesses rather than sole proprietorships. A limited liability company has more significant resources with a neater organizational structure and financial records.
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