Unlimited liability – This is when an owners personal assets are at risk. This means that if the business were to fail and go bankrupt, the owner’s personal assets e.g. their house would be sold in order to try and recover the debt. Sole traders and Partnerships have unlimited liability.
Limited liability – This is when an owners personal assets are not at risk due to the business’s legal identity being separate to the owners. Therefore, the owner is only liable for their original investment if the business was to fail. Both Private Limited Companies (LTD) and Public Limited Companies (PLC) have limited liability.
A) Implications of limited and unlimited liability
Unlimited liability (Sole trader and Partnership)
- Personal assets at risk – The owner could lose their personal assets if the business fails in order to pay off debts.
- Unable to sell shares – Businesses with unlimited liability are unable to sell shares in their business.
- May take less risks – Businesses with unlimited liability are likely to take less risks due to the fact that if the decision goes wrong then they may lose their personal assets if the business fails. This may also mean that banks are more willing to loan them money knowing that they are likely to take less risky decisions, but also that they are able to sell their personal assets if the business fails.
Limited liability (PLC and LTD)
- The owner and business have separate legal identities – This means that the business is able to carry on even if the owner dies.
- The business can sue and can be sued – The business is able to be sued e.g. due to unsafe products and can sue others.
- The business can sell shares – LTD’s are able to sell shares to family as friends whereas PLC’s are able to sell shares on the stock exchange.
- Personal assets are not at risk – If the business fails then the owner will only lose any money that they have invested in the business.
- The business is registered with companies’ house – The business needs to register with the companies’ house before it can become a LTD or PLC.
B) Finance appropriate for limited and unlimited liability businesses
Unlimited liability (Sole trader and Partnership)
- Small loan – Businesses with unlimited liability will still be able to take out loans, however they still may find it difficult and could be charged relatively high interest rates.
- Overdraft – Small businesses may take out an overdraft if they suffer a poor trading period.
- Venture capital – Businesses that are starting up may look at this as a source of finance as well as a way to get business angels on-board with the business and exploit their business knowledge and experience.
- Leasing – Small businesses may lease equipment if they cannot afford to buy it.
- Trade credit – Smaller businesses may use trade credit so they are able to sell their goods before having to pay suppliers.
- Grants – Sole traders and partnerships may be eligible to receive grants.
- Owner’s capital – Sole traders and partnerships are likely to use owner’s capital as a source of finance to reduce the amount of debt that they may acquire.
Limited liability (PLC and LTD)
- Retained profit – PLC’s and LTD’s are likely to receive significant amounts of profit. As a result of this, they are likely to be able to use it in order to invest in big business projects such as expansion.
- Sale of assets – PLC’s and LTD’s are likely to have a large number of assets, some of which they may not need and therefore can sell them for money.
- Loans – Large businesses will be able to take out substantial loans due to the big reputation that they have. They will also be able to do this at a relatively low interest rate due to the bargaining power that business gain when they grow in size.
- Share capital – PLC’s and LTD’s are able to sell shares in their business. PLC’s are more likely to do this due to the large amounts of money that they can make selling shares on the stock market.
- Overdrafts – This may be a source of finance used if the business has a business has a low acid test ratio and therefore cannot pay some of its current liabilities.
- Leasing – Large businesses may lease equipment if it is only needed for a short period of time.
- Trade credit – Businesses may use trade credit if they want to improve their cash flow.
- Grants – The government is much more likely to give grants to larger businesses due to the large number of jobs that they offer.