Limited and Unlimited Liability

The most important difference between incorporated and unincorporated businesses is who is liable for the debts of the business if it fails?

The answer to this question lies in the essential difference between an incorporated and unincorporated business which is this:

• An incorporated business is a separate legal entity. It exists separate from its owners (shareholders).
• An unincorporated business is inseparable from the business owners

The Protection Provided by Limited Liability

The concept of limited liability is an important protection for shareholders in a company.

What this means is that shareholders can only lose (are therefore liable for) the value of their investment in the share capital of the company. However, limited liability does not protect against wrongful or fraudulent trading or when directors give personal guarantees.

The reason why limited liability arises for shareholders is because the company has a separate legal identity. The shareholders are not the same as the business.

Unincorporated Businesses have Unlimited Liability

The most important drawback of operating as an unincorporated business (e.g. sole trader or partnership) is that the owner is liable for the debts of the business.

If the business fails and is left owing money to suppliers, the bank or the tax authorities, these debts can be recovered from the business owners regardless of how much they are.

You might ask, therefore, why would any sane person set up as a sole trader or partnership when setting up a private company is so quick and cheap?