Limited liability: Overview, definition and example
What is limited liability?
Limited liability refers to a legal principle where a business owner's financial responsibility for the company's debts or obligations is restricted to the amount of their investment in the company. This means that personal assets of the business owner, such as their house or personal savings, are generally protected from being used to cover business debts.
Why is limited liability important?
Limited liability is important because it protects business owners from significant financial risk. It encourages entrepreneurship by allowing individuals to start and run businesses without the fear of losing their personal assets. For companies, this can also attract investors who are more likely to invest in a company if their risk is limited to their investment.
For example, in a limited liability company (LLC), the owners (or members) are only responsible for the company's debts up to the amount they invested. If the LLC goes into debt, creditors can only pursue the assets of the business, not the personal property of the members.
Understanding limited liability through an example
Imagine you start a small tech company as an LLC. Your company takes out a loan to fund product development but later struggles to pay it back. Since your company has limited liability, your personal assets—like your home or car—cannot be used to pay off the debt. Only the assets owned by the company can be pursued by creditors.
On the other hand, if the company had been a sole proprietorship or general partnership, you could be personally liable for the company’s debts, meaning creditors could potentially go after your personal property to settle outstanding debts.
An example of a limited liability clause
"The liability of the members of the company is limited to the amount of their respective capital contributions and shall not extend to their personal assets."
Conclusion
Limited liability is a key feature of business structures like corporations and LLCs, providing protection to business owners and investors. By understanding limited liability, companies can manage financial risk more effectively and ensure that owners are not personally responsible for the business's debts beyond their investment. This protection fosters entrepreneurship and encourages investment, knowing that personal assets are safeguarded.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.