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Limited Liability

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Business Studies

Why would a business choose to register as a company? Setting up a business as a company has many advantages - including limited liability. To set up your company as a business, you need to register it with a government agency. This process of registering your business as a company is known as incorporation. Now, let's take a look at what this means in more detail.

What limited liability means

Limited liability means that the company is a separate legal entity to its owner or owners. The company as an 'individual' can own assets, equipment, or offices, and is responsible for its own financial losses and debts.

This is the opposite of a business that is set up as a sole trader.

Every company is owned by shareholders, who invest in the business when they buy shares. In case the company fails or goes bankrupt, shareholders cannot lose more money than they initially invested in the company. For instance, they will not lose their personal assets, like their house, if the company fails. This is known as limited liability. The company is a separate entity from its shareholders and it is only responsible for the money that it owes. Limited liability is the opposite of unlimited liability.

Limited liability is important for companies, as it helps them raise money. With limited liability, investors only risk losing the money they have invested in shares. As a result, shareholders are more likely to invest in a company if they know they will not lose their personal assets.

What does it mean to be a private limited company?

Many businesses choose to operate as private limited companies. Unlike sole proprietorships or partnerships, a limited company is its own separate legal entity. This means that the owners or shareholders are not personally liable for the losses of the company. A private limited company can be owned by an individual, a group of individuals, or another corporate entity (another company).

Within private limited companies, the owners can decide who they sell shares to in the future. For example, if the company is a family business, the owners have the power to limit the sale of shares exclusively to their family. As a result, in the event of selling shares, shareholders of private limited companies cannot publicise the sale of their shares and have to sell them privately.

Specsavers is an example of a private limited company in the UK. Specsavers was originally launched by a couple, around forty years ago. They worked together to expand their business to over a dozen countries worldwide. The reason Specsavers remains a private limited company is due to the couple wanting to keep ownership and control of the company within the family. Other than ownership, there are certain reasons why the owners would want to keep their company private, rather than public (see below). One of these reasons is the long-term interest of the company.

What it means to be a public limited company

Public limited companies tend to be large businesses and many of them are well-known internationally. Public limited companies also benefit from limited liability.

Similar to private limited companies, public limited companies are owned by shareholders. Owners of the company, however, cannot limit who they sell shares to, unlike within private limited companies. Shareholders can sell their shares to whoever they want, which could lead to potential problems, for example if another company or individual starts buying up all the shares. If this happens, it's called a takeover.

The price per share of public companies is publicly accessible to everyone, unlike those of private companies. Companies can attempt to advertise their shares in order to raise capital quickly.

You probably already know dozens of public limited companies, as they tend to be large-scale and well-known. Good examples include Apple, Amazon, and Nestlé.

Advantages and disadvantages of limited liability

Limited liability companies, as opposed to sole traders or partnerships, have some advantages and some disadvantages.

Advantages

There are many advantages to being a limited liability company. Some of the key advantages are:

  • Owners are not personally responsible for the losses and debts of the company - limited liability.

  • The company is a separate legal entity.

  • No restriction on the number of owners.

  • Easier access to capital and resources (compared to a sole proprietorship).

  • The business can raise finances through share capital.

  • Flexibility when it comes to company management.

  • The potential to benefit from economies of scale (lower per-unit cost as production increases).

Disadvantages

However, there are also some disadvantages to consider when setting up a limited liability company. Some disadvantages:

  • It is expensive to set up if the company is just starting.

  • It also takes longer to set up due to the formal company registration process.

  • Taking care of accounting and taxes is more complicated for a limited liability company than for certain other forms of business.

  • You must pay your shareholders dividends. You cannot keep all the profits your company makes.

  • The interest of shareholders and owners could differ, leading to issues with the long-term outlook of a business.

  • Takeovers are also a possibility for public limited companies, which can lead to a loss of control for the current owners.

Limited Liability - Key takeaways

  • Incorporation is the process by which you set up your company as a separate legal entity.
  • A company is a separate legal entity to its owner or owners. The company as an 'individual' can own assets, equipment, or offices, and is responsible for its own financial losses and debts.
  • Limited liability means that if the company faces problems or debts, the shareholders do not risk losing their personal assets. Shareholders will not lose an amount that exceeds their initial investment.
  • Shareholders can receive a part of the company's profits in the form of dividends.
  • There is a difference between private and public limited companies.
  • Private limited companies tend to be smaller and the owners can decide who they sell shares to.
  • Public limited companies tend to be larger and do not get to decide whom they sell shares to. Their shares can be publicly advertised.
  • Some of the advantages of a limited liability company are:
    • Owners are not personally liable for the losses the company incurs.

    • No restriction on the number of owners.

    • The business can raise money through share capital.

  • Some of the disadvantages of a limited company are:

    • Paying shareholders dividends.

    • Possibility of takeover.

    • Conflict of interest.

    • Takes longer to set up.

Limited Liability

Limited liability is a type of legal protection for owners and shareholders of a company, which protects them from personal liability for the losses and debts of a firm. In the event of a company experiencing financial difficulties, the personal assets of its shareholders and owners are safe. This is because a limited liability company is a separate legal entity of its own (shareholders are separate from the company). 


Limited liability ensures that the personal assets of the owners and shareholders of a company are safe. If the company were to experience financial difficulties, shareholders would only lose up to the amount they originally invested in the company when they bought. Limited liability ensures that their personal belongings are kept safe, even if the company is struggling financially. 


It depends on the type of partnership that is set up. It is possible to set up and incorporate a limited liability partnership, in which case each partner has limited liability. In a limited liability partnership, the firm is a separate legal entity to its owners. On the other hand, it is also possible to set up a general partnership, in which case one or both of the partners are personally liable for the debts of the firm. They hold unlimited liability. A general partnership is similar to the sole trader form of business.


Companies have limited liability in order to establish that the company itself is a separate legal entity to its owners and shareholders. This way, the shareholders of the company are not personally responsible for the debts of the company if the company were to experience financial difficulties. It is a way of protecting the personal assets of shareholders from being used to cover the debts of the company. 

Final Limited Liability Quiz

Question

What is incorporation?

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Answer

Incorporation is a process through which a business establishes itself as a company. Through incorporation, the business establishes that it is its own legal entity, separate from its owners and shareholders. It allows the company to benefit from limited liability. 


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Question

What is limited liability?

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Answer

Limited liability ensures that the personal assets of the owners and shareholders of a company are safe. If the company were to experience financial troubles, shareholders would only lose up to the amount they originally invested in the company when they bought shares. Limited liability ensures that their personal belongings are kept safe, even if the company is struggling financially.

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Question

What is the difference between limited liability and unlimited liability?


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Answer

In limited liability companies, the company is a separate legal entity to its owners. This means that they are not personally responsible for the debts of the company. In an unlimited liability business, the owner is personally responsible for the debts of the business. This means that if the business were experiencing financial difficulties, the personal assets of the owner are at risk.

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Question

Is it possible to set up a limited liability sole proprietorship?


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Answer

No, it is not possible to set up a limited liability sole proprietorship. The owner of a sole proprietorship has unlimited liability, meaning that their personal belongings and assets are at risk if the business is experiencing financial difficulties. 


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Question

What is a dividend?


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Answer

A dividend is a part of the firm's profits that is paid to its shareholders. The more shares an owner has in the company, the more dividend payments they receive.

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Are dividend payments equal to the original investment shareholders made into the firm?


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Answer

No. Dividends are paid based on the profits the company has made. This does not mean that shareholders receive the value of their original investment each time a dividend is paid to them.

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Question

Why do companies have limited liability?

  1. Because owners do not want to be taxed. 

  2. Because they do not want to pay dividends. 

  3. Because they do not want to be incorporated. 

  4. Because owners do not want to be personally liable for losses. 

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Answer

D.

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Question

A difference between a limited liability company and a sole proprietorship is that: 


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Answer

A limited liability company can own property and a sole proprietorship cannot

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The difference between a private limited company and a public limited company is that:


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Answer

Private limited companies can decide who they sell shares to but public limited companies cannot

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Question

What type of company would be at risk of a takeover?

  1. Private limited company 

  2. Public limited company

  3. Sole proprietorship 

  4. Partnership

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Answer

B.

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Question

Imagine you are running a family business. The business is doing really well, so you decide you are going to incorporate your business. What type of company would you set up if you did not want to risk the family business getting into the hands of non-family owners?


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Answer

You would set up a private limited company. This type of company would ensure that the owner (you) has control over who the company sells its shares to. 


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Question

What are some of the advantages of a limited liability company?


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Answer


  • Owners are not personally responsible for the losses and debts of the company - they have limited liability.

  • The company is a separate legal entity.

  • No restriction on the number of owners.

  • Easier access to capital and resources (compared to a sole proprietorship).

  • The business can raise finances through share capital. 

  • Flexibility when it comes to company management.

  • The potential to benefit from economies of scale. 

Show question

Question

What are some of the disadvantages of a limited liability company?

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Answer

  • It is expensive to set up if the company is just starting up. 

  • You must pay your shareholders dividends. You cannot keep all the profits your company makes.

  • Takeovers are also a possibility for public limited companies, which could lead to a loss of control for the current owners. 

Show question

Question

One of the disadvantages of a limited liability company is that: 

  1. There are restrictions on the number of owners.

  2. There are restrictions on the number of shares you can sell. 

  3. The owners are personally liable for the debts of the company. 

  4. The company is potentially at risk of takeovers.

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Answer

D.

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Question

Other than limited liability, what are some of the advantages of operating as a limited liability company?


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Answer

  • Easier access to capital and resources (compared to a sole proprietorship).

  • The business can raise finances through share capital. 

  • Flexibility when it comes to company management.

  • The potential to benefit from economies of scale. 

Show question

Question

Limited liability means the company has to take full responsibility for its own financial losses and debts. 

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Answer

True

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Question

What is the opposite of a limited liability company?

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Answer

A sole trader

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Question

Who are shareholders of a company?

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Answer

Someone who invests in the business when they buy the business shares.

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Shareholders can lose more than the money they've invested if the company fails or goes bankrupt. 

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Answer

True

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Limited liability allows companies to raise money. 

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Answer

True

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Question

Who can own a private limited company?

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Answer

An individual

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Public limited companies tend to be big and well-known international companies.

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Answer

True

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Question

Give some examples of public limited companies you know

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Answer

Amazon, Apple, Nestle

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What is not an advantage of a limited liability company?

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Answer

The company is a separate legal entity 

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What would happen if a limited company is taken over?

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Answer

Takeovers can lead to a loss of control for the current owners. 

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Can limited liability business owners keep all the profit the company makes?

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Answer

No, they have to pay shareholders dividends (unless they choose to reinvest the profit)

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What are the disadvantages of limited liability companies?

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Answer

Possibility of takeover 

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Question

Shares of public limited companies can be publicly advertised. 

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Answer

True

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Question

It is easier for a limited liability company to take care of its accounting and taxes than other forms of business.

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Answer

True

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Question

Private limited companies tend to be ... and the owners can decide to whom they sell shares. 

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Answer

small

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