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Understanding limited liability when buying a business

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What does limited liability mean for a business buyer?

When searching for a business to buy, the legal structure of the business is key to the decision-making process as it will determine how to operate the business, liability for business debts, accounting obligations, tax treatment and ownership rights. There are many legal operating structures that include a partnership, limited liability partnership (LLP) limited company and sole trader business. 

We explain what limited liability means, what it means for business owners and different business structures that may be considered when buying a business.

What is limited liability?

Limited liability is a form of legal protection for business owners from being held personally liable for business debts, as a limited company and limited liability partnership provide.

A limited company is classed as a legal entity in its own right and is therefore separate from the shareholders that own the company and the directors that manage the business. As such, any liabilities will remain the responsibility of the business if it enters financial difficulty or becomes insolvent. If the business runs out of cash, company creditors will not be required to personally repay the debts of the business and their personal assets will be protected.

A limited liability partnership grants protections to the partners that enter the agreement as it is a separate legal entity to its members. The liabilities of each partner will be limited to the amount that they invested in the business. If the partnership runs up debts, creditors will be unable to pursue the partners personally or repossess their personal assets.

Is limited liability an advantage?

Buying a limited company is often an attractive option as business buyers can operate the business with limited risk exposure, should it run into financial difficulty. This is a major advantage as the business owner may have the appetite to responsibly take on greater risks as they are protected.

Operating a business without limited liability protections in place exposes the business owner to unlimited liability, such as a sole trader business. As there’s no legal distinction between the business and the individual, the business owner will be held personally responsible for the debts of the business and this will not be capped.

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Are there exceptions to limited liability?

There are a few exceptions to personal liability under which the director of a limited company can be held personally liable for the debts of the business. From signing a personal guarantee to director misconduct, here are some of the circumstances under which the business owner will not be protected by limited liability.

  • Personal guarantee – A personal guarantee agreement is sometimes required when taking out a business loan as it provides extra security to the lender. Under a personal guarantee, the borrower uses a personal asset, or assets as security to cover the loan repayment if the business becomes insolvent.
  • Overdrawn director’s loan – If the director takes out a loan from the business, also known as a director’s loan, they will need to repay this personally. If they extract money from the business while it is in financial distress, further worsening its financial position, the consequences are severe.
  • Director misfeasance or fraud – If a director fails to fulfil their directorial responsibilities and protect the interests of creditors, they could be held personally liable for company debts. The same follows for director misconduct and director misfeasance which is a term that covers incorrect actions carried out by creditors.
  • Insolvent trading – If the director continues to pay shareholder dividends and trade while the business is insolvent, which is known as insolvent trading, they could be held personally liable for the debts of the business as this runs the risk of running up more debts to creditors.

Limited liability is desired by business owners as it protects against personal liability for business debts, subject to the above, which can make running a business smooth sailing in the face of unchartered risks.

Understanding business structures

When looking to buy a business, strategically look at the business structure and assess what this means to you as a future buyer. The limited liability aspect will mean different things to each individual, although the risk appetite will essentially determine the next step, whether this is to buy a sole trader business, buy a limited company or enter a business partnership. 

Limited liability grants a layer of protection and additional security to you on a personal level and for your finances and assets, such as your family home, car, and investments. As such, there are nearly four million limited companies recorded on the Companies House register, a testament to the popularity of this business structure.

For more information on buying a business, valuing a business, or financing a business acquisition, get in touch with a member of the Selling My Business team of business brokers.

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