Limited liability is a structure used in business that prevents the owner from being personally liable for business costs and losses. Limited liability essentially places a boundary between the owner’s business assets and personal assets. This type of protection prevents the business owner’s personal assets from being considered in legal matters or bankruptcy.
Understanding how limited liability works is important if you are in the beginning stages of forming your business. Learning about the benefits can help prepare business owners as they make decisions about their business structure upon registration. Whether you’re leaning toward running a sole proprietorship or planning to operate a limited liability company, understanding how limited liability works can impact how you decide to conduct business.
Definition and Examples of Limited Liability
Limited liability is a structure used in business to protect the owner’s assets–and the investors’. These assets include personal property, such as houses and vehicles. Under limited liability, the owner’s property is not at risk because it is considered to be completely separate from the assets of the business. This structure protects the owners and investors from being held liable for any decisions made by the business which result in debt.
This legal protection is included in several business structures, including limited liability companies (LLCs), limited liability partnerships (LLPs), and corporations. Depending on your business needs, you can choose which structure is best suited for your business. You should assess your business plan, consult a lawyer, and consider which structure works best for you.
How Limited Liability Works
Limited liability offers protection for business owners as well as their investors. The structure of limited liability provides a separation between the owners and their business matters, allowing the business to stand alone as its own entity when facing legal matters or bankruptcy. Whatever costs the business incurs will be repaid by the business itself since it is seen as a separate legal entity.
In case of bankruptcy, for example, owners, investors, and shareholders will not be held liable for the debts. This means their personal assets, such as their house, their savings, or any other kind of personal assets are not at risk and cannot be used for any sort of repayment regarding business costs. To receive this protection for your business, you must register it as one of several structures that include limited liability protection. Three types of structures limit an organization’s liability:
- A limited liability company (LLC)
- A limited liability partnership (LLP)
- A corporation
Make sure to look into the laws for your state when forming your business, as fees, taxes, and other requirements may vary from state to state.
Since limited liability technically “limits” an owner’s liability for business debts, there may be instances where they could be held liable. This usually occurs when the owner engages in general misconduct, such as combining their personal assets with business assets, concealing certain information about the company, or taking part in fraudulent activities. This is what is known as “piercing the corporate veil.”
Types of Limited Liability Business Structures
When you decide to form your business, you will have several options regarding its structure, the most basic one being a sole proprietorship. You can choose this option if you want to control all business decisions. You won’t have the hassle and expense of registering, but you also won’t receive the benefits of limited liability. If you want the protection that limited liability offers, consider registering your business as a limited liability partnership, limited liability company, or corporation.
You may find that other business structures, such as a sole proprietorship or a limited partnership (LP), are a better fit for your business. These structures don’t offer liability protection but are often used for startups, as they are easier to set up in the beginning stages.
If you do go the route of a sole proprietorship or a limited partnership, though, consider the risks. Investors may be more hesitant to fund your business since they won’t be protected by limited liability.
Limited Liability Partnership (LLP)
A limited liability partnership (LLP) is formed by two or more owners who are considered equal owners of the business. Registering your business as an LLP will prevent all owners from being liable for decisions regarding the business that result in losses or debts. This structure is usually formed by certain professionals, such as lawyers and doctors.
Limited Liability Company (LLC)
A limited liability company (LLC) is a business structure that requires more than the LLP, but it is still more simplified compared to a corporation as it doesn't have as many obligations. The LLC can have one or multiple owners (referred to as members), and each is protected by limited liability. When it comes to taxes, LLCs may be classified in one of several ways, depending on the number of owners and the tax forms that are filled out. All in all, LLCs require more paperwork than a sole proprietorship, though the tax rate is lower than a corporation’s rate.
A corporation is a type of business structure made to be completely separate, standing alone as its own legal entity. Corporations have more obligations when it comes to operations and cost more to form, but they also offer more protection than any other structure. Corporations face higher taxes. These taxes are levied on both the corporation itself and its shareholders, essentially creating a double tax.
- Limited liability is a protection provided by certain business structures that separates an owner’s assets from their business’s assets. This prevents the owner from being personally liable for business debts.
- Business owners, investors, and shareholders are not liable for business debts, legal matters, or bankruptcy when protected by limited liability.
- Corporations, limited liability companies, and limited liability partnerships are examples of different business structures offering liability protection.