Question on limited liability

QAHi Luke,

I would just like to know how is limited liability a benefit for the business example in a private limited company or a public limited company?

As far as I understand it is a benefit for the shareholder as they can not be held responsible for any loss made the business or loose any thing more than the money they invested into the business.

How is this a benefit to the business? Is it because shareholders are more likely to buy shares in the business as they know the most they can loose is the money they invest in the business in buying shares?

Regards Carla

Hi Carla

Thanks for the question – it’s a good one, and you have just about given a good answer to it yourself.
Limited liability implies that if a company (private limited company or public limited company) fails, shareholders stand to lose only their initial investment when they purchased shares in the company. A court, for example, cannot seize the assets of the company’s shareholders.
As a result, shareholders – and potential shareholders – have much more peace of mind and security, knowing that their liability is limited. They don’t have to guess an amount that they are risking or have an open-ended question here; rather, shareholders are aware that their liability is equal to their initial investment. Also remember that limited companies have their own legal identity. In other words, they are seen as a separate entity – different to that of owners (shareholders) and management.
This is beneficial for businesses, as this kind of shareholder confidence makes companies an attractive option for investments. If shareholders have more security because of limited liability, they are much more likely to purchase shares and therefore provide finance for growth and expansion of the company. Hence we find that businesses are able to expand after ‘going public’ (listed on a stock exchange such as the JSE or the NYSE).
There is a second important consequence of limited liability: should the business fail, those who stand to lose the most are the creditors of the business. Creditors are those institutions – such as investment banks – that have loaned finance to the company. Should the business fail, these creditors may not be able to retrieve the finance loaned to the firm (note that creditors also includes suppliers that offer resources on credit).
For more on this, check out the following links:
I hope this helps to answer your question!
Regards

Luke

 

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