Unlimited Liability Meaning
Unlimited liability means the legal commitment of owners of the business as they are liable for all business debts if the assets of the firm/ business cannot meet its debts or liabilities. In short, the liability of the owners towards the business is unlimited. The general partners/ sole proprietors have the responsibility for the business actions, and it may end up even in the confiscation of their personal assets’ if the business cannot pay off their liabilities.
Examples of Unlimited Liability of Partnerships/Company
Let’s see some examples of unlimited liability of partnership/company to understand it better.
Three individuals working as partners, and each invest $10,000 into the new business which they own jointly. Over the period, the liability of the business accrues to $90,000. If the firm (business) is unable to settle the liabilities or defaults on the payments to be made then all three partners are equally liable to settle the liabilities. That means apart from the initial investment of $10,000 now each partner individually needs to invest another $20,000 to settle the liabilities of the firm.
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The above example indicates how unlimited liability in partnership works. If the business is not able to meet its liabilities, then the owners are responsible for paying them. The risk is more in this, as even the personal assets of the owners can also be seized for business liabilities.
Lawsuits can create a big impact on the sole proprietor/ general partners with unlimited liability. If any client sues against the business, and the business cannot settle the dues to be paid post-judgment, then the client can sue the general partners/ proprietor to settle the dues. If they don’t have enough funds to settle the dues, then the personal assets will be seized.
Unlimited liability is not considered as favorable as it can involve the personal assets of the owners. This is one of the major reasons for forming limited liability partnerships and limited liability companies as they offer some protection to the owners against the liabilities of the business. Registered companies and corporations work with the limited liability of the shareholders, it indicates that the liabilities of the business are not guaranteed, and the same cannot be forced on the shareholders.
Joe started a new restaurant. he took a place for rent, took furniture and other facility requirements on hire. The business went well for the first year. Due to the increasing competition, the business was not doing well. So Joe decided to shut down the business. When he closed down the business, he had to pay his creditors $20,000. The initial investment made by him was $10,000. So joe now has a further liability of $10,000. Since it was a sole proprietorship, the left out of liability of $10,000 needs to be settled by him from his personal assets.
In the above case unlimited liability is not favorable to Joe since his personal assets (ie) cash of $10,000 is being used for a business purpose on the closure of a business. If the business was carried out on a limited liability basis, then for the liability of $20,000 which is to be paid, $10,000 the initial investment of joe alone would have been considered for the settlement of dues and his personal assets will remain untouched for the business actions.
Advantages of Unlimited Liability
Some advantages of unlimited liability are as follows:
- Owners have the ultimate power and complete control over the business. they are free to make all business decisions within the law.
- Establishing and organizing sole proprietorship and general partnership firm is easy.
- Dissolving of the business is easy as the owners take all decisions.
- All the income generated from the business can be taken by the owners.
- Complete confidentiality of the business can be maintained as the owners have complete control.
- Management decisions will be improved and cautious as there is a risk of personal liability for the business actions.
- Creditors and other stakeholders will have more confidence in the business, as there is unlimited liability for the owners. The business owners will also be careful in business operations as they have complete responsibility.
- The share capital and the initial investment is at the flexibility of the owners as there will not be any pressure for fixed contribution.
Disadvantages of Unlimited Liability
Some disadvantages of unlimited liability are as follows:
- Unlimited liability makes the owners legally responsible for all the debts and liabilities of the business.
- In business with unlimited liability, both the business and personal assets of the owners may be at risk.
- With unlimited liability, the owners will be careful in decision making, which can slow down the developments of the business as they will refrain from taking any risky business decisions. The business can even lose some good opportunities because of this.
- Acts of all stakeholders can have an impact over the owners (eg) even an act of an employee which is unlawful can put the owners at risk.
- The growth of the business is purely in the hands of owners, as the business will cease to exist if the owner leaves, retires or dies.
- It has a restrictive structure, as there is no proper legal status and differentiation between the owners and business. in other words, business and the owners are the same.
- The results and performance of the business are kept confidential. mismanagement of the business can never be known to the outside world unless the business goes bankrupt.
Unlimited liability in business has its own advantages and disadvantages. The formation of business regarding its liability has to be considered based on the nature of the business, owners’ capacity considering finance, skills, investment, etc. Unlimited liability is suitable for small businesses as the risk and rewards are less for the same. When the business grows, then it is better to convert it into a limited liability as the risk grows if the volume of business is huge, so with unlimited liability owners may not have the confidence of taking risky decisions which can impact the growth of business and many opportunities will be lost.
This has been a guide to what is unlimited liability and it’s meaning. Here we discuss the examples of unlimited liability along with advantages and disadvantages. You can learn more about financing from the following articles –