Debitoor Dictionary

Accounting terms explained in a simple way

Over 150 Articles for Founders and Entrepreneurs

  1. Assets
  2. Corporation
  3. Liabilities
  4. Limited company
  5. Partnership
  6. Sole trader

Limited liability – What is limited liability?

Limited liability is a form of legal protection for shareholders and owners that prevents individuals from being held personally responsible for their company’s debts or financial losses.

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Within some business structures, such corporations and limited companies, organisations are registered as distinct legal bodies. Because these kinds of businesses are legally classified as a ‘person’, they are able to:

  • Keep finances separate from the owners’ personal finances.
  • Own assets and keep any profits after tax.

By separating the finances of the owners and the business, the business becomes responsible for its liabilities, debts and financial losses.

This distinction creates a legal protection for owners and shareholders, who are under no legal obligation to pay any debts or cover any losses if the business were to fail.

Any assets which personally belong to an owner or shareholder cannot be seized in order to repay the debt – therefore the only potential loss is any capital that has already been invested into the business.

Unlimited liability and sole traders

The alternative to limited liability is unlimited liability. Some kinds of business partnership have unlimited liability, as do all sole traders.

Within the sole-trader business structure, there is no legal distinction between the business and the owner. Whilst this means that sole traders can keep all profits they make after tax, they are also responsible for any losses incurred by their business and may need to repay debts out of their own pocket.

Although unlimited liability may be an obvious drawback of the sole trader structure, if you’re thinking about whether or not to incorporate, this should be weighed up against the relative ease and low cost of remaining a sole trader.