What is unlimited liability in business?
The Companies Act 2006 outlines the different types of company in the UK, their legal obligations, and how they should be structured. This includes whether a business has limited or unlimited liability in relation to their debts.
In this guide we’ll look at what unlimited liability is and how it compares to limited liability, as well as outlining some of the advantages and disadvantages of unlimited liability.
First of all, let's look at limited liability.
What is limited liability?
In business, the liability structure determines who is responsible for the company’s financial obligations, both present and future. A limited liability company offers financial protection for the owner by keeping their business and personal assets separate.
If a limited liability company has debts, becomes insolvent, or is sued, the most the owner is personally liable for is the face value of their investment in the business. Any further amount is then paid out of the company’s assets, or the business may be liquidated if the outstanding liabilities cannot be covered.
In the UK, there are two types of limited liability companies: public (PLC) and private (Ltd). There are several key differences between the two, including requirements for minimum share capital, how stocks are traded, the number of directors, and whether a company secretary is required.
What is unlimited liability?
Unlimited liability doesn't afford protection of the owner’s personal assets. As the name suggests, there is no cap to the owner’s liability, either by law or by contract.
Legally speaking, the company and its owners or partners are seen as the same entity. This means that if the business experiences financial difficulties, is unable to pay its debts, or is required to settle legal proceedings, creditors are permitted to seize the owner’s personal assets to cover any remaining liabilities.
There are two different types of unlimited liability: sole proprietorship and unlimited liability partnerships.
Unincorporated organisations where one individual has complete control over the business don't have the protection of limited liability. The owner alone is responsible for any debts or expenses accrued by the business, and their personal assets may be at risk.
Sole traders have unlimited liability by default. This means that, unless they choose to incorporate, the individual who started the business is personally liable for any and all business debts. It’s generally considered good practice for sole proprietors to take out professional indemnity or public liability insurance to protect their assets.
Unlimited liability partnerships
Unlimited liability partnerships are formed when two or more people start a business together. Each partner can make decisions on the other’s behalf that may create obligations for them. For example, if one owner takes out a business loan, all other partners will share liability for the debt.
In unlimited liability partnerships, all partners are personally liable for the businesses’ debts in equal amounts unless stated otherwise by the partnership agreement. While trust is always an important part of choosing a business partner, this is especially true in unlimited liability structures.
What is the difference between limited and unlimited liability?
In an unlimited liability structure, there is no legal distinction between the business and its owners. Creditors can therefore seize any personal assets and property in order to pay the debts of the business. On the other hand, limited liability means that the business and its owners are discrete entities. This keeps any personal assets separate from the business and safe from seizure.
The big difference between limited and unlimited liability from an owner’s perspective is the amount of risk they’re willing to take. Limited liability presents a much smaller risk, as the business can simply be declared bankrupt and dissolved if it hits financial difficulties. This offers protection for business owners, partners, and shareholders.
Unlimited liability advantages
While an unlimited liability structure presents more risk to the business owner and partners, there are several advantages that may make it an attractive option in certain circumstances.
Unlimited liability companies are easy to set up and dismantle, and don’t have legal requirements for shares, directors, and structure. As there are no shareholders to dispute their business decisions, owners have much more freedom and flexibility than owners of limited companies. Unlimited liability also tends to offer more freedom around compliance regulations, accounting.
No disclosure requirements
While limited companies are legally required to make certain records available to the public, this is not the case for unlimited liability companies. This means that there aren’t any public records or reports of how the business is operating, such as financial statements, changes in directorships, details of new shares issued, or reductions in share capital. You might choose this approach if you want to protect the privacy of the business and its owners.
Business owners can make tax savings when operating as an unlimited liability company, as any losses incurred can be offset against other income. Because the owner’s business and personal finances are legally the same, they can also freely borrow from the business to cover their own personal expenses if needed. This can’t be done in a limited liability company, as the business and its owner are considered separate entities.
Unlimited liability disadvantages
Of course, there are also disadvantages to unlimited liability. These include:
Risk to personal assets
The most obvious disadvantage of unlimited liability is the risk to the owner’s personal assets. There is no cap on the amount of money they could be liable for, so unforeseen circumstances, an unfortunate mistake, or poor business decisions could be financially devastating. This can be particularly damaging if they support dependents or have personal debts, loans, or a mortgage.
Difficulty securing a loan
Owners of unlimited liability companies may find it more difficult to secure a business loan. Lenders weigh up the risk associated with an investment when deciding whether to accept a loan application, and the possibility of the business being responsible for an unlimited amount is understandably less attractive.
If they are able to secure a loan, unlimited liability businesses may be limited in how much they can borrow. They might also be subject to higher interest rates than if they operated a limited company.
Potential missed opportunities
The fact that owners and shareholders of an unlimited liability business can be liable for debts might dissuade them from taking risks. While this may help the business to grow sustainably and avoid high-risk situations, it could also mean missing out on big opportunities that could lead to expansion and greater success.
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