A disadvantage of partnerships over corporations is the partners unlimited liability

Unlimited Liability Meaning

Unlimited liability means the business owners’ legal commitment as they are liable for all business debts if the assets of the firm/ business cannot meet its debts or liabilities. In short, the liability of the owners towards the business is unlimited. The general partners/ sole proprietors are responsible for the business actions. It may end up even confiscating their assets’ if the business cannot pay off their liabilities.

Examples of Unlimited Liability of Partnerships/Company

Let’s see some examples of unlimited liability of partnership/company to understand it better.

Example #1

Three individuals work as partners, and each invests $10,000 into the new business they own jointly. Over the period, the liability of the business accrues to $90,000. That means apart from the initial investment of $10,000. Each partner needs to invest another $20,000 to settle the firm’s liabilities. If the firm (business) cannot settle the liabilities or defaults on the payments to be made, then all three partners are equally liable to settle the liabilities.

Analysis

The above example indicates how unlimited liability in partnership works. If the business cannot meet its liabilities, the owners are responsible for paying them. The risk is more in this, as even the owners can also be seized for business liabilities.

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Example #2

Lawsuits can greatly impact the sole proprietor/ general partners with unlimited liability. If any client sues against the business and cannot settle the dues to be paid post-judgment, then the client can sue the general partners/ proprietor to settle the dues. If they don’t have enough funds to settle the dues, personal assets will be seized.

Unlimited liability is not considered favorable as it can involve the owners’ assets. It is one of the major reasons for forming limited liability partnerships andLimited liability refers to that legal structure where the owners' or investors' personal assets are not at stake. Their accountability for business loss or debt doesn't exceed their capital investment in the company. It is applicable in partnership firms and limited liability companies.read more limited liabilityLimited liability refers to that legal structure where the owners' or investors' personal assets are not at stake. Their accountability for business loss or debt doesn't exceed their capital investment in the company. It is applicable in partnership firms and limited liability companies.read more companies as they offer some protection to the owners against the business’s liabilities. Registered companies and corporations work with the limited liability of the shareholders, which indicates that the business’s liabilities are not guaranteed, and the same cannot be forced on the shareholders.

Example #3

Joe started a new restaurant. He took place for rent, took furniture, and other facility requirements on hire. The business went well for the first year. Due to the increasing competition, the business was not doing well. So Joe decided to shut down the business. When he closed down the business, he had to pay his creditors $20,000. The initial investment made by him was $10,000. So Joe now has a further liability of $10,000. Since it was a sole proprietorship, the left out of liability of $10,000 needs to be settled from his assets.

Analysis

In the above case, unlimited liability is not favorable to Joe since his assets (i.e.) cash of $10,000 is being used for a business purpose on the closure of a business. If the business were carried out on a limited liability basis, then for the liability of $20,000, which is to be paid, $10,000 the initial investment of Joe alone would have been considered for the settlement of dues and his assets will remain untouched for the business actions.

Advantages of Unlimited Liability

Some advantages of unlimited liability are as follows:

• Owners have the ultimate power and complete control over the business. They are free to make all business decisions within the law.
• Establishing and organizing sole proprietorship and general partnership firm is easy.
• Dissolving the business is easy as the owners take all decisions.
• The owners can take all the income generated from the business.
• Complete confidentiality of the business can be maintained as the owners have complete control.
• Management decisions will be improved and cautious as there is a risk of personal liability for the business actions.
• Creditors and other stakeholders will have more confidence in the business, as the owners have unlimited liability. The business owners will also be careful inBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more business operationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more as they have complete responsibility.
• The share capitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side.read more and the initial investment are at the flexibility of the owners as there will not be any pressure for fixed contribution.

Disadvantages of Unlimited Liability

Some disadvantages of unlimited liability are as follows:

• Unlimited liability makes the owners legally responsible for all the debts and liabilities of the business.
• In a business with unlimited liability, both the business and personal assets of the owners may be at risk.
• With unlimited liability, the owners will be careful in decision making, which can slow down the developments of the business as they will refrain from taking any risky business decisions. The business can even lose some good opportunities because of this.
• Acts of all stakeholders can impact the owners (e.g.). Even an act of an employee which is unlawful can put the owners at risk.
• The growth of the business is purely in the hands of owners, as the business will cease to exist if the owner leaves, retires, or dies.
• It has a restrictive structure, as there is no proper legal status and differentiation between the owners and businesses. In other words, business and the owners are the same.
• The results and performance of the business are kept confidential. Mismanagement of the business can never be known to the outside world unless the business goes bankrupt.

Conclusion

Unlimited liability in business has its advantages and disadvantages. The formation of a business regarding its liability has to be considered based on the nature of the business, owners’ capacity considering finance, skills, investment, etc. Unlimited liability is suitable for small businesses as the risk and rewards are less. When the business grows, then it is better to convert it into a limited liability as the risk grows if the volume of business is huge, so with unlimited liability, owners may not have the confidence of taking risky decisions which can impact the growth of business and many opportunities will be lost.

Recommended Articles

This has been a guide to unlimited liability and its meaning. Here we discuss the examples of unlimited liability along with advantages and disadvantages. You can learn more about financing from the following articles –

• Sole Proprietorship vs Partnership
• Joint Venture vs Partnership
• LLC vs Partnership
• Limited Partners vs General Partners
• Loan Capital