Limited and Unlimited Liability Businesses PDF

**LIMITED LIABILITY AND UNLIMITED LIABILITY BUSINESSES** Whether business owners have limited liability or unlimited liability depends on the legal status of their businesses. This may take one of two different forms. 。 Unlimited liability businesses. These are businesses where there is no legal...

**LIMITED LIABILITY AND UNLIMITED LIABILITY BUSINESSES** Whether business owners have limited liability or unlimited liability depends on the legal status of their businesses. This may take one of two different forms. 。 Unlimited liability businesses. These are businesses where there is no legal difference between the owners and the business. They are sometimes called an unincorporated business. Everything is carried out in the name of the owner or owners. These firms tend to be small, owned either by one person or a few partners. The owners of these businesses will have unlimited liability. Limited liability businesses. A limited liability business has a legal identity separate from its owners. In other words, the business (as opposed to the owners) can be sued, taken over or liquidated. These firms are sometimes called an incorporated business. The owners of these businesses will have limited liability. **ADVANTAGES AND DISADVANTAGES OF UNLIMITED LIABILITY** Business owners with unlimited liability are exposed financially to the failure of their businesses. If their business collapses while owing money to external parties, such as banks, suppliers and the tax authorities, the owners will have to meet these debts from their personal resources. This means that if owners do not have the money to pay off these debts they can be forced to sell private assets to raise the necessary cash. For example, a sole trader can be legally required to sell a house to raise funds to meet a demand from the tax authorities. This is regardless of the hardship this might cause for the owner and their family. This highlights the risk taken by entrepreneurs when setting up an unincorporated business. Owners of businesses with unlimited liability are also liable for any unlawful acts committed by the owners or the employees. For example, if an employee wrote something libellous about someone, that person might be able to claim compensation from the business owner. If the business does not have enough money to pay, the owner would again have to use private funds. The owners may also be financially liable if sued successfully by other stakeholders, such as customers, employees or suppliers. This all arises because there is no separation of legal identity between the business and the owners. **ADVANTAGES AND DISADVANTAGES OF LIMITED LIABILITY** The owners of businesses with limited liability are shareholders. The main advantage of this is that shareholders\' financial liability is limited to the amount of money they invested in the business. It is a fixed sum and equal to the amount of money they paid for their shares. If a limited company collapses, the owners\' private assets are fully protected. Shareholders cannot be legally forced to sell personal assets to meet the business\'s debts. Shareholders also have protection from legal claims on the business. This is because the owners and the business have separate legal identities. For example, if a customer sues a limited company for damages, there can be no claim on the private wealth of the business\'s shareholders if the business cannot pay the compensation. However, there are exceptions to this rule. Courts may decide that individuals are liable if a crime has been committed or if the company has failed to maintain adequate records and accounts, hold annual general meetings or file annual reports. This might be more likely to happen with private limited companies. Because shareholders\' private assets are protected, limited companies may find it easier to raise larger amounts of money from investors. As a result investors are more willing to buy shares in limited companies because they know precisely the extent of their liability - it is limited to the size of their investment. However, in some cases the owners of small limited companies, who are frequently also shareholders, are required to give personal guarantees of the company\'s debts to those lending to the company. They will then be liable for those debts in the event that the company cannot pay, although the other shareholders will not be. The method of finance chosen by a business can be influenced by a number of factors. Whether short-term or long-term finance is needed: If a business needs to borrow money for a lengthy period of time, say 10 years or more, certain types of funding are more suitable than others. For example, mortgages can be taken out for 25 years. Unsecured bank loans may be granted for 1 to 5 years. Debentures can be issued for up to 30 years. Share capital - money raised from the sale of shares - is permanent capital and never repaid. This is the most long-term finance method. A business is not likely to use trade credit, bank overdrafts or leasing for long-term funding. These are more suitable for short-term borrowing. The financial position of the business:The financial situation of businesses is constantly changing. When a business is in a poor financial situation, it finds that lenders are more reluctant to offer finance. At the same time, the cost of borrowing rises, Financial institutions are more willing to lend to secure businesses, which have a large amount of collateral. The type of expenditure for which the money is needed: When a company undertakes heavy capital expenditure, it is usually funded by a long-term source of finance. For example, the building of a new factory might be financed by a share issue or a mortgage. Revenue expenditure tends to be financed by short-term sources. For example, the purchase of raw materials might be funded by trade credit or a bank overdraft. Cost: Businesses will prefer sources and methods that are less expensive, both in terms of interest payments and administration costs. For example, share issues can carry high administration costs, while the interest payments on bank overdrafts tend to be relatively low. The legal status of the business: This will depend on whether a business has limited or unlimited liability. This is discussed in more detail below. **FINANCE APPROPRIATE FOR UNLIMITED LIABILITY BUSINESSES** Unlimited liability businesses, such as sole traders and partnerships, have fewer sources and methods of finance to choose from. They are most likely to include some of the following. 。 Personal savings. Most small business owners with unlimited liability are likely to use their own money to set up a business. It is an important source of finance.. Retained profit. This source can only be used if the business survives and becomes established. As the business develops it must generate enough profit to support both the owner and future business investment. However, for many unlimited liability businesses, the scope for using retained profit is restricted.. Mortgage. It is common for unlimited liability businesses to use the owner\'s house as collateral for a business loan. This provides a source of long- term finance. However, the owners are at increased risk. If the business goes into heavy debt and fails, the owners can suffer serious financial hardship such as losing their homes. Unsecured bank loans. On occasion, banks might advance unsecured loans to established and successful businesses. This might depend on the financial climate at the time of request. For example, banks may have tighter criteria for unsecured bank loans if there is a credit crunch. Owners must be prepared to produce detailed business plans to obtain bank loans. Peer-to-peer lending (P2PL). Small business owners can raise finance through dedicated websites from people interested in lending money to their enterprise, thus avoiding the need for a bank. However, some P2PL funding is not available to businesses. The owners will have to check with individual P2PL sites to see whether businesses can borrow. Crowd funding. Crowd funding can provide long- term finance for businesses. Once this new concept has had time to develop and prove to be reliable, it could well become a very popular source for unlimited liability businesses. Bank overdraft. Most businesses will have access to a bank overdraft. However, the size of the overdraft limit will vary considerably. Established and profitable businesses will have access to much larger overdrafts than those that are not. Grants. These can provide a \'free\' source of finance to unlimited liability businesses. However, businesses have to prove that they qualify for grants and some owners might be put off by the lengthy application process. All of the finance sources outlined above are appropriate for unlimited businesses because they are accessible to small businesses. Businesses with unlimited liability tend to be small and often struggle to raise finance. Such businesses have access to fewer sources because they have fewer assets that can be used as collateral. Also, they may be new start-ups with no trading record, which can often discourage lenders. However, it must be remembered that there are exceptions to these rules. For example, the owners of unlimited liability businesses have to meet business debts from their own resources, so lenders might be repaid if a business collapses, **FINANCE APPROPRIATE FOR LIMITED LIABILITY BUSINESSES** Generally, limited liability businesses,particularly plcs, have a much wider range of funding opportunities. Some methods of finance, such as shares and debentures, for example, are only available to limited companies. The main advantage for limited liability businesses is that they tend to be larger than unlimited liability businesses and have more resources to support loans. Consequently, they are less risky for lenders and other investors. Appropriate sources of finance for limited liability businesses include the following.. Share capital. The sale of shares allows limited companies to raise very large amounts of capital. Share capital is provided by the owners of the business from their own resources. Once shares are purchased, the money raised is not normally repaid to shareholders, so the capital remains in the business for as long as it is trading. Also, a business might raise more money in the future by selling more shares. They may use a rights issue, for example. This is where existing shareholders are given the \'right\' to buy new shares at a reduced price. This is cheap and simple and creates free publicity. The number of shares offered is based on current holdings; for example, a one-for-five issue means that shareholders can buy one new share for every five that they currently own. Rights issues are also normally regarded as a cost- effective way of raising fresh capital. Debentures. Public limited companies can raise large amounts of money by selling debentures. This loan capital can be very long term - up to 30 years. One key advantage of this method to the business is that, unlike shareholders, debenture holders do not have any control over the business. Retained profit. Around half of all business finance comes from retained profit. Limited liability businesses are no exception. Some very large companies have hundreds of millions of pounds in cash reserves, which have accumulated over the years. Some of this is likely to be used by the. business in the future.. Venture capitalists. The majority of finance provided by venture capitalists finds its way into limited companies. One reason is because they usually take a share in the business, thereby having some control over the key decisions. Venture capitalists also like to invest larger amounts of money than business angels - several million pounds sometimes. However, they are also prepared to invest in small- and medium-sized enterprises. Business angels. Business angels may provide funds for both limited and unlimited liability businesses. They will normally take a share in the business, but this does not mean they will avoid sole traders and partnerships. They are also more inclined to invest at an earlier stage than venture capitalists. One problem with business angels is that they are often difficult to find. This sometimes means that entrepreneurs spend too long searching for suitable angels when their time could be better spent focusing on the development of the business.