The degree to which owners are liable for company debts plays a big role in the size of the business. Unlimited liability tends to keep proprietorships and partnerships relatively small. Limited liability allows corporations to be significantly larger.

Unlimited Liability

For example, consider a proprietorship such as Phil Gardener's zucchini growing operation. Should Phil come up on the losing end of a law suit filed by a customer who purchased a bad zucchini, then Phil is liable for this business debt. In addition to the "company" bank account, Phil also might need to tap into his personal bank account, sell off most of his personal property, or take out a second mortgage on his house to pay this debt.

Also consider how unlimited liability affects a partnership such as the legal firm of Schrumpmeyer and Schrumpmeyer, owned and operated jointly by Sean and Sally Schrumpmeyer. Should Sean incur several sizeable debts (for luxurious office furniture, business trips, and legal malpractice suits), then Sally also can be held responsible for payment. In addition to the "company" bank account, Sean and Sally might need to tap into their personal bank accounts, sell off some of their personal property, or take out second mortgages on their houses to pay the debts of the business.

Limited Liability

Consider how unlimited liability works for a hypothetical corporation like InkBlot Print Shop, Inc. InkBlot is a relatively small corporation owned and operated by college friends, Jennifer Blotbug and Kyla Inkster. Out of 100 shares of corporate stock, each owns 50. While Jennifer and Kyla could have established InkBlot as a partnership, they chose instead a corporation. The corporation provides limited liability.

Should an employee incur extravagant hospital bills after losing an appendage in the printing machinery, then the liability faced by Jennifer and Kyla for this debt is limited by the assets of InkBlot Print Shop, Inc. Neither owner can be forced to use their personal wealth or assets to pay the bills.

Pros and Cons

• Accumulating Resources: Limiting liability to the value of the ownership shares makes it possible for a business to 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, a corporation can accumulate $100 million by selling 1 million shares of limited liability ownership stock to 1 million people each paying $100. Should problems arise, each person is liable ONLY for $100. Accumulating the same $100 million with unlimited liability would be substantially more difficult (and probably impossible). If each of the 1 million owners is held personally responsible for company debts, then they would likely want a great control of the decision making process.

  The ease of accumulating large amounts of resources means corporations can take advantage of large scale production. Larger factories generally mean average production cost declines with increased production.



• Creating Incentives: The prospects of unlimited liability creates incentives for business owners to weigh every decision carefully. A single bad decision, a single mistake, can decimate the company and destroy the personal wealth of the owners.

  Alternatively, the protection provided by limited liability does not force owners to take personal responsibility for their decisions. A string of bad decisions might force the company into bankruptcy, but the owners can survive with their personal wealth largely intact.