Limited Liability Meaning
Limited Liability is a type of legal structure that protects the shareholders and owners against any form of personal liability for losses and debts and ensures that their liability is limited to the amount invested in the company.
Earlier, the law used to take action against the partners or the owners of the company during the time of the dissolution of the business. Respective partners or the owners of the company had to bear the liability during dissolution.
Types of Limited Liability
Based on the basis of organization limited liability can be classified into two types such as
#1 – Limited Liability Company (LLC)
Companies that have limited liabilities and the owners are not responsible for the liabilities of the business.
#2 – Limited Liability Partnership (LLP)
The Limited Liability Partnership can be termed as the partnership firms where the partners are not responsible for the borrowings of the business. The management of the partnership firms does not have an obligation to repay their personal assets.
Examples of Limited Liability
Let’s understand examples of limited liability.
ABC LLP is a limited liability partnership (LLP) with an equity base of $12,000 where there are three partners namely Tom, Dick, and Harry. The Firm has taken a loan of $50,000 during the financial year. Next year, the firm was charged for non-payment of interest on the loan and non-payment to the creditors, and finally, according to the law, the partnership firm got dissolved. Because of LLP, the liabilities of the three partners remained at Tom, Dick, and Harry to $12,000. Not a single asset was taken by them to repay the debt.
A private limited company named XYZ LLC is a limited liability company (LLP) with an equity share capital of $2,00,000 where there are four owners namely Mike, Dawson, Nathen, and Alex. The Company has taken a loan of $50,00,000 during the financial year. Next year, the firm was charged for non-payment of interest on the loan and non-payment to the creditors, and finally, according to the law, the partnership firm got dissolved. Due to the nature of the company (i.e LLC), the liabilities of the four directors Mike, Dawson, Nathen, and Alex. Were limited $50,00,000 and they were not obliged to pay any amount other than the share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side..
Advantages of Limited Liability
The major advantages are summed up as follows:
- The liability of the organization is limited to the resources of the business only. Owners, stakeholders, and the directors are not responsible to pay the debt of the business during dissolution.
- Earlier, the promoters, owners, and the directors held responsible for paying the entire amount of the loan taken irrespective of the nature of the loan taken. After the inception of the Limited Liability concept, the promotors are only responsible for the amount of stake they have in the business. They might lose to the extent of this amount only.
- This concept prevents the interest of the shareholders by protecting their personal assets. Due to the involvement of this concept, the shareholders will not be motivated to invest in the company’s stake. The primary reason being, the security of their investment.
- Thus, due to the involvement of the Limited Liability concept, elite shareholders undertake new ventures and thus enhances the business possibilities in the economy.
- During any unsatisfactory claims by the creditors, the partners were held responsible to pay the liabilities of their respective firms. In the case of the distribution of profits, the untaxed profit amount is given to the partners. The partners are responsible to pay the tax amount individually. In case of distribution of dividends, the shareholders are responsible to pay the taxable amount on the dividends.
Some of the limitations are as follows:
- This concept does not capture the true business outcomes. The dissolution of a business can be because of several reasons like economic sluggish growth, wrong projections by the management, mismanagement by the company personnel, fund siphoning by the top management, etc. Thus, due to these above factors, the loan providers get impacted. Thus, the responsible group is actually not obliged to pay the price.
- The policymakers could not stop the growth in non-performing assetsNon-performing AssetsNon-Performing Assets (NPA) refers to the classification of loans and advances on a lender's records (usually banks) that have not received interest or principal payments and are considered "past due." In the majority of cases, debt has been classified as non-performing assets (NPAs) when loan payments have been outstanding for more than 90 days. in the economy, which might result in lower investor sentiment, leading to lower CAPEX growth and low business activities across the economy.
- Primary loan providers such as the banks, the financial banks tend to take the burden of the limited liability organization
- The partner’s or owner’s capitalOwner's CapitalOwners Capital, also known as Shareholders Equity, is the money invested in a business by the owners (in the case of a sole proprietorship or partnership) or shareholders (in the case of a corporation) and is the portion of the total assets funded by the owners/shareholders money. remains limited to the extent of the investment made by them.
- This concept is applicable to two types of organizations namely limited liability company (LLC) and limited liability partnership (LLP).
- The burden of loans will not be charged by the partners or the owners of the organization.
- The concept does not apply in the case of a sole proprietorship business.
- It protects the interest of the investors and helps to retain the consumer investment sentiment.
This has been a guide to what is a limited liability and its meaning. Here we discuss two types of limited liability companies along with examples, limitations, advantages, and disadvantages. You can learn more from the following articles –