Limited liability means that the owners of a business are NOT personally liable for the debts incurred by the business. The business is considered a legal person that is fully and completely responsible for its debts. Limited liability for a corporation means that the owners can ONLY lose the value of their ownership shares. The worst that can happen to stockholders is that the company goes out of business and the stock becomes worthless. A corporation CANNOT force shareholders to use funds in their bank accounts or to sell their houses and cars to pay company debts.
Corporations have limited liability because the business is considered a distinct legal entity, separate from the owners. The company is responsible for its debts. The owners are responsible for debts ONLY up to the value of the ownership shares, and no more. Limited liability makes it easier for a business to accumulate large amounts of productive resources that can be used for large scale production.
OmniConglomerate, Inc.Consider how limited liability works for a corporation like OmniConglomerate, Inc. OmniConglomerate is a large multinational corporation owned by millions of people around the globe. One notable owner is Winston Smythe Kennsington III, who also happens to be Chairman of the Board of Directors and President of the company. As President, Winston Smythe runs the company. He is the guy in charge. He makes the big decisions.
Other Kennsington family members are also major owners of OmniConglomerate. Winston's grandfather, Winston Smythe Kennsington I, owns thousands of shares of the company he began as a small bicycle repair shop. Winston's father (Winston Smythe Kennsington II), brother (Thurston Smythe Kennsington), and sister (Geraldine Constance Kennsington), also own ample shares of OmniConglomerate stock.
As a corporation, the Kennsington family assets are protected by limited liability. Bad business decisions made by Winston Smythe III might cause economic loses for OmniConglomerate, Inc., which would then reduce the value of the OmniConglomerate stock owned by the Kennsingtons. And really bad business decisions might force OmniConglomerate out of business entirely, making the stock totally worthless. However, in either event, the liability of the Kennsington owners is limited to the value of their OmniConglomerate stock.
Best of all, millions of others who own OmniConglomerate stock (even though they do not share the Kennsington family name) also risk ONLY the value of their OmniConglomerate stock. Their liability to the company is limited to their ownership shares. They do NOT risk any personal assets.
An Unlimited AlternativeA comparison between partnerships and corporations illustrates the difference between limited liability and unlimited liability. Both types of business organizations can be owned by several individuals. The prime difference is that corporation owners have limited liability while partnership owners have unlimited liability.
Because a corporation has limited liability, should the business incur sizeable debts, then each owner, each person who owns shares of the company's stock, stands to lose NO more than the value of the stock. The worst that can happen to the stockholders is that the company goes out of business and the stock becomes worthless.
In contrast, unlimited liability for a partnership means that EVERY partner can be held liable and responsible for any and ALL debts of the other partners. Each partner can be forced to use any and all personal wealth to cover the debts of the partnership.
If OmniConglomerate is organized as a partnership, for example, owned jointly by assorted members of the Kennsington family, then each of the Kennsington's would have unlimited liability. Should Winston Smythe III make several really bad business decisions, then Winston Smythe II, Thurston Smythe, and even Geraldine Constance would ALL be liable for any ensuing debts. Winston Smythe II might be forced to sell his summer home in the Hamptons. Thurston Smythe might have to sell his winter home in the Bahamas. And Geraldine Constance might be forced to part with her prized (and extremely valuable) collection of antique coins.
Few Limits on SizeLimiting personal liability to the value of the ownership shares makes it possible for corporations to accumulate large sums of money and thus gain control over large quantities of productive resources. Rather than relying ONLY on the resources owned by one person (as with a proprietorship) or that owned by a handful of people (as with a partnership), corporations have almost no limits to the accumulation of productive resources.
For example, OmniConglomerate can raise $100 million by selling 1 million shares of corporate stock to 1 million different people each paying $100. This money can then be used to build factories, purchase equipment, hire employees, and buy material inputs. Should problems arise, each person is liable ONLY for $100.
These 1 million owners are more likely to buy into OmniConglomerate if the full extent of their liability is $100 than if ALL of their personal wealth and assets is also at risk as would be the case for a partnership.
Other OrganizationsThe advantage of limited liability found with corporations has prompted the development of other business organizations that operate like proprietorships or partnerships, but which also have limited liability. Three notable examples are S corporation, limited partnership, and limited liability company.
- S Corporation: A type of corporation, with limited liability for the owners, that makes use of a special section of the Internal Revenue Service tax code (Chapter S) to avoid the double taxation of income. Like a proprietorship or partnership, the profit of an S corporation is considered the income of its owner or owners and is thus taxable only as individual income.
- Limited Partnership: A partnership in which one or more of the partners has limited liability, but one partner has unlimited liability. This differs from regular partnerships in which every partner has unlimited liability. The limited partnership legal structure was created to provide liability protection to "partners" seeking investment opportunities comparable to stock ownership of a corporation.
- Limited Liability Company: A firm that operates very much like a partnership, but in which each owner has limited liability. The advantage of a limited liability company, over a limited partnership, is that every owner has limited liability.
LIMITED LIABILITY, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2019. [Accessed: December 10, 2019].