Definition: Limited liability protects an owner, so he or she can’t lose more money than he invested in an investment. In other words, it refers to the amount of risk an investor takes when he invests in a company. Depending on the way a company is organized, the owners can actually lose more than their investment if the company goes bankrupt.
What Does Limited Liability Mean?
Corporations are one of the only business structures that have limited liability and protect owners’ personal assets. This is because the corporation is legally recognized as a separate entity than its shareholders. Thus, if someone tries to sue the company for damages, they will not be able to sue the shareholders too. The most the shareholders can lose in the lawsuit is their original investment in the company (their shares).
Let’s take a look at a few examples.
Assume Sam invested $100 in Big Apple, Inc. A year after his investment, a customer slipped and fell on the sidewalk outside the store and sued the company. The company lost the lawsuit and went bankrupt. Now Sam’s shares are worthless and he lost his $100 investment. The customer cannot then go after Sam, as an owner of the company to recover more money because he and the corporation are separate entities.
Now let’s assume the same set of circumstances except Sam invests $100 in his sole proprietorship. Sole props and owners are viewed as the same thing. There is not separation of entities and thus no protection from liability. Sam has unlimited liability in this business. In other words, he is on the hook personally for everything. The customer can sue the business and Sam personally for damages. If Sam loses the personal lawsuit, he may lose his house, car, or any other personal possessions.
That is why limited liability protection is extremely important.