Q&A - What is unlimited liability?

There is a big downside to operating as a sole trader. It occurs because, in the eyes of the law, there is no difference between the person running the business and the business itself. When it comes to chasing money owed by a business, a sole trader has to settle up.

The sole trader is, therefore, liable for any debts that the business incurs.

If the business takes out a loan or buys goods and services on credit, then the sole trader himself/herself is liable to repay the debt. This is known as the important concept of unlimited liability.

As a sole trader is personally responsible for any debts run up by the business, this means the home or other assets owned by the entrepreneur may be at risk if the business runs into trouble.

This sounds like bad news, and for some sole traders the nightmare sometimes becomes reality. Thousands of people become personally bankrupt in the UK each year, many of whom have built up trading debts which they find they are not able to repay.

So why would anyone set up as a sole trader given the risks posed by unlimited liability? There are two main reasons:

(1) Setting up as a sole trader is so easy; setting up a company is (wrongly) perceived as being a bit of a hassle. So simple laziness leaves sole traders at risk

(2) Some trades have a low risk of failure – where the sole trader buys and sells in cash and does not need to invest significantly