Section 2.1.31 Liability and Finance Flashcards
liability and finance
every potential entrepreneur needs to know the financial risks being run when starting up. debts are liabilities that can overwhelm a business owner’s personal as well as business finances
unlimited liability
the finances of the business are treated as inseparable from the finances of the business owner(s)
if the business loses $1 million than what happens in unlimited liability
the people owed money (the creditors) can get the courts to force the individual owners to pay up through selling their houses, cars, etc. if they have to
if the owners can’t pay in unlimited liability then what happens
they can be made personally bankrupt
two types of business organisation have unlimited liability:
sole traders and partnerships
limited liability
the legal duty to pay debts run up by the business stays with the business itself, not its owner/shareholders
if the company has $1 million of debts that it lacks cash to repay then what happens in limited liability
the courts can force the business to sell all its assets (cars, computers, etc.)
if the company can’t pay in limited liability then what happens
the company is closed down, but the owner/shareholders have no personal liability for the remaining debts
the key implication of limited liability:
gives the owners the confidence to push their business forward to the next level
expansion can be financed by bank loans without threatening the well-being of the owners families
without the legal protections of limited liability, what would happen
economies would struggle to grow
downside of limited liability:
it gives huge scope for fraud. it is hard to to distinguish between fraud (illegal) and incompetence (legal), which is why it’s hard to be certain that it is fraud
if it is limited liability:
- personal protection from business debts
- no stress from this source
if it is not limited liability:
- unlimited personal liability for business debts
- adds greatly to stress level
what are unlimited liability businesses not and what does this mean
they are not companies. therefore, they have no access to share capital (equity), so a sole trader or a partnership must be financed in one of four ways
the four ways a sole trader or partnership must be financed in unlimited liability:
1) owner’s capital
2) bank finance, either loan or overdraft
3) leasing
4) trade credit
owner’s capital in unlimited liability
an agreement might be drawn up by basing the proportionate ownership of the business on the amount of capital invested by each partner
bank finance in unlimited liability
either loan or overdraft. often easier for an unlimited liability business to obtain this because even if the business fails, the bank can recoup its cash from the personal assets of the individual owners
leasing in unlimited liability
signing an agreement to rent a specific asset for a specific period of time, therefore avoiding the cash drain caused by purchase
trade credit in unlimited liability
supplier companies would often prefer to deal with a sole trader or partnership, as they know they can recoup any debts from the individual owners if the business fails
where does the most important form of capital come from
within the business: from trading profit
what do companies have more access to
more types of finance than unlimited liability businesses
both private and public limited companies have access to the 5 forms of finance:
1) share capital
2) bank finance
3) angel or venture capital investment, both of which tend to be a combination of share and loan capital
4) peer-to-peer or crowdfunding
5) leasing and trade credit are both open to limited liability companies
share capital in limited liability
part of which may be under the control of the founder and part sold on to family and friends (ltd) or more widely to the general public (plc)
bank finance in limited liability
typically need to be backed by specific collateral, especially for small companies (banks are wary of limited liability).
overdrafts will also need to be backed by security; for new small companies, it is highly likely that a bank would demand a personal guarantee by the founder shareholder
angel or venture capital investment in limited liability
both of which tend to be a combination of share and loan capital
: founder suffers dilution of control over the business and the company will probably find that the loan capital is at a much higher interest rate than an ordinary bank loan
peer-to-peer or crowdfunding in limited liability
tend to keep control more effectively in the hands of the founder
for limited companies, even giant plcs, where does the biggest source of capital for expansion come from
within the business: from trading profit
bankrupt definition:
when an individual is unable to meet personal liabilities, some or all of which can be as a consequence of business activities
creditors definition:
those owed money by a business - for example, suppliers and bankers
limited liability definition:
owners are not liable for the debts of the business; they can lose no more than the sum they invested
sole trader definition:
a one-person business with unlimited liability
unlimited liability definition:
owners are liable for any debts incurred by the business, even if it requires them to sell all their assets and possessions and become personally bankrupt
why would anybody start a business with unlimited personal liability
don’t know, but the majority of uk business have unlimited liability, as proprietors believe there are tax advantages and dislike the extra fiddle and admin costs of running a company
why might it be easier for a partnership to raise finance for expansion than a sole trader
simply because the partnership has more than one owner, i.e. there are more pockets to dip in to
why might suppliers refuse to give credit to a new small company
a company, by definition, has limited liability. so suppliers are wary of giving credit when, if the company fails, there is no way to recoup the cash from the business owners
why don’t companies by assets outright, surely it is cheaper in the long run than leasing
it is, but many firms are so strapped for cash that they take a long-term hit from leasing to gain improved short-term cash flow
why do companies pay dividends when the profit they make is so important for financing growth and avoiding debt
shareholders expect an income from their investment; only early-stage, fast-growers such as snapchat can get away with paying no dividends
how expensive is it to run a company instead of a sole trader
not that costly. you can form a company for little more than $100, and the ongoing accounting costs are around $1,200 a year
