What is Limited Liability in a Business?

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What is Limited Liability in a Business?

Why is limited liability important?

Before we dive into why limited liability is so important, we need to answer the question ‘what is limited liability in business?’ Limited liability is the protection you receive as a limited company, should your business face financial difficulties. As a limited company, your business is legally classified as an ‘individual’ and separate legal entity to you and other owners.

Limited liability is important to protect you against the unexpected. So, if your business ever struggles with debts, financial losses or liabilities, the business itself is responsible for them - not you personally. This means you wouldn’t be liable for these financial hardships and all your personal assets would be secure. You would be legally protected and wouldn’t be obligated to pay any debts or cover any financial losses, should your business fall through. The same protection applies for your shareholders too - they have no legal obligation to pay more than the nominal value of shares they hold.

Take a look at the advantages and disadvantages of limited liability for more information.

What is a sole trader?

If you’re self-employed, run your own business as an individual and work for yourself, this is known as being a sole trader. As a sole trader you’re in control of your business, its profits after tax and any assets.

But unlike a limited company, as a sole trader you are personally liable for your business’ debts, meaning if your business struggles financially your personal assets may be at risk - we’ll explore this in more detail below.

Does it really make a difference if you’re a sole trader or a limited company?

It’s easy to assume there aren’t many differences to being a sole trader or a limited company - they both involve running a business after all! But there are significant differences between forming a limited company and becoming a sole trader.

Here are some of the biggest differences between being a sole trader and a limited company:

Liability: As mentioned, as a limited company you gain limited liability meaning your personal assets are protected should your business suffer financially. A limited company is treated as a separate legal entity from its owners and shareholders are also protected. Whereas as a sole trader, you are personally liable for all your business’ debts.
Company size: Sole traders are considered self-employed, whereas limited companies can vary in size.
Decision-making: Sole-traders are personally responsible for business decisions as they operate as one individual. Whereas limited companies often have several decision-makers, such as shareholders.

What is unlimited liability?

By having unlimited liability you’re legally responsible for your business’ debts. This means there is no legal distinction between your business and you personally. If your business runs into financial difficulties, you’ll be financially responsible and creditors can seize your personal assets and property to repay your business’ debts. With this in mind, you may choose to form a limited company instead to mitigate risk to your new business.

What other types of businesses have limited liability?

As we’ve explained, a limited company limits the amount of liability taken on by its owners and shareholders. Limited liability serves as a form of legal protection and prevents you from being responsible for your company’s financial losses.

Here are some other types of businesses that have limited liability:

Public limited companies (PLCs)

A public limited company is a type of business that is managed by directors and owned by its shareholders. A PLC can offer shares of stock to the public and the buyers of those shares have limited liability - so won’t be liable if the business struggles financially in excess of the amount they paid for the shares. Because PLCs are listed on the stock market, they need to be transparent about their financials and must make their financial reports public so potential shareholders can read up on them before investing.

Limited liability partnerships (LLPs)

Another type of business structure is a limited liability partnership. A LLP works in a similar way to a limited company in that it is treated as a separate legal entity and is incorporated with Companies House. As the name suggests, a limited liability partnership also offers limited liability to its members. LLPs must be profit-making businesses and be formed by two or more people. Unlike limited companies, there are no shareholders, shares or directors in limited liability partnerships.

Limited by shares vs limited by guarantee

As mentioned, limited companies provide their business owners with limited liability. But before you go ahead and register your new limited company, you’ll need to decide which type of limited liability best suits you - limited by shares or limited by guarantee.

The type of limited liability you should choose will depend on the industry you’re looking to operate in and the type of business you’re striving to build. Here are the differences between limited by shares and limited by guarantee:

Limited by shares

A business limited by shares is set up with share capital, meaning you must divide your company into shares and choose shareholders. The value of shares owned by each shareholder represents the amount of control and ownership they have, and the limit of their personal liability for business debts. A limited-by-shares company must have at least one share and one shareholder - so you can choose to set up this type of business by yourself. But you also have the choice to divide the company into several shares and have multiple shareholders.

Limited by guarantee

You may choose for your company to be limited by guarantee. Limited-by-guarantee companies are usually not-for-profit organisations like charities. Instead of shares being issued, all profits are kept within the company. Rather than shareholders, limited-by-guarantee companies are owned by guarantors who pay a fixed amount of money, known as a guarantee, towards the business’ debts should the business struggle financially. This financial guarantee is the limit of a guarantor’s personal liability to the company, which is typically a nominal amount, often as little as £1.

Both models of incorporation offer directors the protection of limited liability, if their business faces financial strain such as insolvency.

Are there any exceptions to limited liability?

While limited liability can offer you protection if your company struggles financially, there are some exceptions where you may be personally liable. The protection that comes with limited liability can be withdrawn should you commit negligence or other unlawful actions. Here are just some scenarios where you may be held personally liable for your company’s debts:

Continuing to trade once your company has become insolvent. This includes paying dividends to shareholders and disposing of business assets below their market value
Not filing your annual confirmation statement to Companies House
Misusing company funds
Breaching data protection, either deliberately or on account of negligence
Ignoring court orders issued to your company
Paying your employees less than the statutory minimum wage
Evading tax
Engaging in fraudulent activities

Form your limited company today

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Starting your own business can feel daunting - but it doesn’t need to be. Why not let us take care of things? Start Up A-Z can help you form your limited company in no time, so you have one less thing to worry about. Apply to form your company and prepare for your life-changing next chapter.