Liability (Edexcel A Level Business)

Revision Note

Limited & Unlimited Liability

  • The most common forms of business ownership are sole traders, partnerships, private limited companies, public limited companies, and franchises (see sub-topic 1.5)

  • When an entrepreneur starts a business, they need to consider what kind of legal structure they want for their business

  • Sole traders and partnerships offer no legal protection to the owners in that the business assets and the owner's personal assets are viewed as being the same (unlimited liability)

  • The other forms of business ownership offer limited liability in which the assets of the owners are considered to be separate from those of the business

A Comparison of Unlimited & Limited Liability

Liability

Description

Implications

Unlimited liability

  • Sole proprietors and partnership owners are fully responsible for all debts owed by the business

  • Owners are also legally responsible for any unlawful acts committed by those connected to the business

  • There is no legal distinction between owners with unlimited liability and the business

  • As a result, these business owners may have to use their own  personal assets to pay debts or legal fees

  • E.g. a sole proprietor may need to sell their home to pay  creditors if their business fails

Limited liability

  • Owners (shareholders) of private limited companies and public limited companies can only lose the original amount they invested in the business if it fails

  • Shareholders are not responsible for business debts

  • In most cases, the shareholders cannot be held responsible for unlawful acts committed by those connected with the business

  • Companies are  incorporated and owners are considered a separate legal entity to the business 

  • This means that if a company fails, the owners would lose their investment (shares) but would not have to use their assets to meet additional debts or legal fees

  • E.g. In 2018 construction company Carillion entered liquidation and the shareholders lost their investments

Appropriate Finance for Limited & Unlimited Liability Businesses

Sources of finance for limited liability businesses

  • There are numerous factors that decide which is the most appropriate form of finance for limited and unlimited liability businesses

  • More often than not there will be a range or blend of sources of finance that a firm can use

Diagram showing sources of finance for limited liability businesses: internal (retained profit, debentures, share capital) and investors (venture capitalists, business angels).

Methods of finance suitable for limited liability businesses 

  • Unlimited liability businesses usually access different sources of funding to limited liability businesses

  • Some sources of funding are suitable for both types of businesses, e.g. an unsecured bank loan

Sources of finance for unlimited liability businesses

Diagram of finance sources for unlimited liability businesses, including personal savings, bank loans, trade credit, leasing, grants, and crowdfunding.

Methods of finance suitable for unlimited liability businesses

  • Businesses need to consider a range of factors before selecting the most appropriate method(s) of finance

Factors Affecting the Choice of Finance

Factor

Explanation

Why is the finance needed?

  • Capital expenditure on buildings and expensive equipment will usually require a longer-term method of finance, such as a mortgage or share issue

  • Revenue expenditure (e.g. purchasing raw materials or paying business rates)  is more likely to be funded through a short-term method such as trade credit or overdraft

For how long and how quickly is the finance needed?

  • For quick, short-term finance, businesses may use methods such as overdrafts, trade credit, short-term loans or leasing

  • If a business needs access to finance over the longer term, methods such as a share issue, debentures, mortgages or grants may be more suitable

Who will lend to the business?

  • Start-ups or struggling businesses may find their choice of finance limited and will often pay much more to access it than more established, stable businesses

  • Businesses that present more of a risk to lenders may choose to raise finance through venture capitalists, business angels or crowdfunding

  • Unlimited liability businesses, as well as businesses that own few assets, often struggle to raise finance as they’re seen as risky

How much will it cost, and how easy is it to access the finance?

  • Methods of finance that attract interest, e.g. loans, mortgages and overdrafts, are less affordable for businesses when interest rates are high

  • Interest-free methods of finance are usually more complex to access, e.g. share issues and grants

What is the legal status of the business?

  • Unlimited liability businesses often struggle to raise finance

    • They may be small, own few business assets (e.g. to use as collateral) or have a limited trading record

  • Lenders (e.g. banks) prefer to lend to more established businesses that own assets

  • Investors prefer to invest in limited companies as they are often able to obtain a share in the business

Examiner Tip

You are sometimes required to recommend a suitable source of finance to meet the needs of the business presented in a case study.

Whilst candidates are often able to effectively analyse the benefits and drawbacks of each of the available methods and make a judgement, the very best responses take into consideration the specific circumstances of the business. The table above provides some structure for that discussion.

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