If an LLC goes bankrupt and its assets aren’t sufficient to cover its debts, who ends up being responsible for the shortfall?

[Yash Chopra]

If an LLC goes bankrupt and its assets aren’t sufficient to cover its debts, who ends up being responsible for the shortfall?

[Simon Haughtone]

I believe that the owners or members of an LLC are not personally liable for the company’s debts, meaning they risk only their investment in the LLC. Does this imply that creditors extending loans to the LLC face the possibility of not recovering their lent amounts if the LLC fails? If that’s the case, what incentives do lenders have to provide financing to these businesses?

[Allen Paul]

Yes, creditors who finance LLCs indeed face the risk of not recovering their investments if the company dissolves without enough assets to fulfill its debts.

The willingness to lend to an LLC, however, varies based on the company’s individual circumstances. Many LLCs, including smaller ones, have been operational for years and possess solid financial foundations, making them relatively low-risk for lenders.

This factor contributes to why numerous small businesses choose not to incorporate as limited companies; the perceived risk would likely deter lenders or result in higher interest rates compared to personal loans to the business owners.

Typically, small limited companies begin with initial funding from their founders or evolve from pre-existing non-limited enterprises. When banks do provide loans to these companies, they usually secure them against tangible assets, like property.

[Raabiya Issac]

While theoretically, the shareholders of an LLC are not personally liable for the company’s debts, in reality, there is typically someone who is accountable for these debts, or the debts are backed by some form of collateral. For instance, in smaller LLCs, the owner often has to personally guarantee any unsecured credit. Conversely, in larger LLCs seeking to borrow, the company usually has to offer some assets (like property or machinery) as collateral to secure the loan.

An instance where an LLC might incur unsecured debt is through trade credit, where a selling company allows the LLC to purchase goods on terms, fully aware of the risk that they may not be repaid if the buyer goes bankrupt. The seller deems this risk acceptable, considering that offering credit terms enables the purchasing company to buy more goods, potentially increasing sales.

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