What is Limited Liability?
Limited Liability is the legal protection under which the shareholders of privately and publicly owned corporations are not liable to pay for the company’s debts and obligations beyond his or her fully paid-up shares. The company as a legal entity is responsible for the rest of the obligations.
In simple terms if you invest in a company who has a huge bank loan you are not responsible for repayment of the loan.
Why is Limited Liability necessary?
Let’s say there is a crazy businessman who wants to go to Mars. You decide that even though the idea is outlandish you must invest in this venture. The limited liability feature will be the biggest advantage of investing in this company. While you can participate in the growth of the company, your liability is restricted to the amount of the investment in the company. If the company goes bankrupt and has remaining debt obligations you are not liable for any repayments.
Assets belonging to the company, such as real estate, equipment, and machinery, investments made in the name of the company and any goods that have been produced but have not been sold, will be used to meet the obligations.
Without limited liability investors would be reluctant to buy equity ownership in firms, and entrepreneurs would be starved of investments. This is because without limited liability if the company loses more money than it has, i.e. it has more liabilities than assets, creditors would claim the investors’ assets. The most that can be lost by the investor with limited liability is the amount invested, all his other belongings are off limit.
Points to remember
- Protects personal assets of from business failure.
- Is necessary feature of stock markets as it encourages investments in equity.