Risk and Liability
The Meaning of Risk
Risk: the chance that a decision turns out worse than expected, so that a business makes a loss or fails.
Every business takes risks. A new product may not sell, or a rival may open across the road. Starting a business is the biggest risk of all, because the owner puts in time and money before knowing whether anyone will buy.
Entrepreneurs accept risk because of the possible reward. Profit is the return for taking it (see 1.2.1). In general, the riskier the venture, the higher the profit needed to make it worth trying.
Lenders and investors face risk too. A bank that lends to a business may not get its money back, which is why riskier borrowers are charged higher interest (see 1.4.1). How much an owner stands to lose personally depends on whether the business has limited or unlimited liability.
Limited and Unlimited Liability
Unlimited liability: the owners are personally responsible for all of the business's debts, with no limit.
Limited liability: the owners can lose no more than the money they have put into the business.
With unlimited liability, the law treats the owner and the business as the same thing. If the business cannot pay its debts, the people it owes can take the owner's savings, car or house.
A business gets limited liability by becoming a company. A company is a separate legal entity: it owns its own assets, signs its own contracts and owes its own debts. The owners are shareholders. If the company fails, they lose the value of their shares, but the company's debts are not theirs to pay.
Types of Business Ownership
| Type | Liability | Ownership | Access to finance |
|---|---|---|---|
| Sole trader | Unlimited | One person owns and usually runs the business | Owner's savings, bank loans and overdrafts; hard to raise large sums |
| Partnership | Unlimited | Two or more partners share ownership, decisions and profit | Each partner can put money in, so more than a sole trader, but still limited |
| Private limited company (Ltd) | Limited | Shareholders, often family and friends; shares cannot be offered to the public | Can sell shares to chosen investors; banks lend more readily to an established company |
| Public limited company (plc) | Limited | Shareholders, who can be anyone if the shares are listed on a stock exchange | Can sell shares to the public; needs at least £50,000 of share capital |
Implications of Limited and Unlimited Liability
The type of liability matters in four ways:
- For owners: losses capped at what they put in → they can start and grow a business without betting their home on it → more people are willing to take the risk. Unlimited liability is simpler: a sole trader can start straight away, with no forms to file, and keeps their accounts private. But a failed business can leave the owner with debts for years.
- For raising finance: the most an investor can lose is what they paid for their shares → people will buy shares in a company they do not run → a company can raise far more outside finance. This is why a business that wants large amounts of outside finance becomes a company.
- For lenders and suppliers: risk moves from the owners to the people the company owes → if it fails, they may get back only part of what they are owed → banks often ask the directors of a small company for a personal guarantee, and suppliers may give a new company less time to pay.
- For the economy: the downside is capped → more businesses are started and more money is invested in them → more jobs and growth. Limited companies must file their accounts at Companies House, where anyone can read them, which helps lenders and suppliers judge how safe they are to deal with.
Limited liability protects the owners, not the business. A limited company can still run out of cash and close. What changes is how much the owners lose when it does: what they put in, and no more. Use this when a question asks whether becoming a company makes a business safer.
Stuck on this topic? Work through it with an online A-Level Economics tutor in a free 15-minute intro call, or send an essay on it for A-Level Economics essay marking.