Q&A - Explain incorporation and the protection of limited liability

Incorporation is the creation of a company which then operates as a business. In the vast majority of cases, the type of company created is a “private limited company”.

Now, here is the really important part.

In the eyes of the law, limited companies exist in their own right.

This means the company’s finances are separate from the personal finances of their owners. In the case of a company, the owners are known as “shareholders”.

Shareholders may be individuals or other companies. They are not responsible for the company’s debts unless they have given guarantees (of a bank loan, for example). However, they may lose the money they have invested in the company if it fails.

In nearly all cases, the most a shareholder can lose (personally) is the money that has been invested in the shares of the company. To use some important legal wording, the liability of shareholders is limited. Hence - the concept of “limited liability”.

You should be able to see that the idea of limited liability offers an important protection to a company shareholder.

Consider a company that goes bankrupt owing money to suppliers, taxes to the Inland Revenue and perhaps an amount outstanding on a bank loan. Who is liable for these debts? Is it the shareholders of the company? No – they are protected by “limited liability”. It is the company itself that should have repaid those debts. The company will be liquidated and whatever assets are left will be used to pay off some (not all) the outstanding creditors.

What does it cost to get the protection of limited liability? Almost nothing. A private limited company can be set up very quickly and the annual administrative costs of a simple company are unlikely to be more than £500-£1,000. That seems a small price to pay for such an important protection offered to the shareholders.