Businesses fail all the time. That's just the way capitalism works. When a company goes belly-up, it often leaves behind a stack of unpaid bills. Who's responsible for those bills depends on whether the business owner has limited or unlimited liability. If it's limited liability, then the debts belong to the business. If it's unlimited liability, then the owner is personally on the hook for them.
In business, "limited liability" and "unlimited liability" refer to whether the owners of a company can be held personally responsible for the debts of the business. If the company goes bust while owing people money, can those people go after the company owners' personal assets, such as their homes, cars and bank accounts? In a limited liability situation, the answer is no: The owners can lose the money they've invested in the company, but no more. In an unlimited liability situation, the answer is yes: The owners can be held personally liable for all debts incurred by the business.
Whether a company's owners have limited or unlimited liability depends on the structure of the business. A business that's organized as a corporation offers its owners the protection of limited liability. The same is true for "limited liability companies," or LLCs. Corporations and LLCs are legally distinct from their owners; the debts run up by the companies are the responsibility of the companies, not the owners. By contrast, sole proprietorships and general partnerships are not legally distinct from their owners. Their owners are fully responsible for all debts of the business. Therefore, they have unlimited liability.
Limited Liability Advantages
For a business owner or investor, the advantages of limited liability are significant. No one goes into business wanting to lose money, but it's always a possibility. With limited liability, though, the most you can lose is the amount of your investment. If you buy, say, $10,000 worth of stock in a company, you can lose that $10,000 -- but the company's creditors can't come knocking on your door demanding that you cough up more to settle the company's debts. If you're going to invest money in any company, you're probably going to expect and insist upon limited liability protection.
Unlimited Liability Disadvantages
The disadvantages of unlimited liability are just as clear as the advantages of limited liability. There's no cap on how much you can lose. When you have unlimited liability, the failure of your business can cost you everything you own, pushing you into personal bankruptcy. The concept of limited liability is a cornerstone of the modern entrepreneurial system. Innovation comes from entrepreneurs willing to take risks -- but unlimited liability makes many risks unacceptable because the penalties for failure can be so high.
Whether a business owner has limited or unlimited liability doesn't make a whole lot of difference to the customers of the business. The distinction really matters only when the company is in trouble and unpaid bills are piling up. Those bills will generally be from business creditors, such as suppliers and vendors, rather than customers. Still, if a company fails while owing money to customers -- such as deposits or refunds -- those customers have the same right as anyone else who is owed money to try to collect. If it's an unlimited liability company, that right includes going after the owner's personal assets.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.