Greedy Goblin

Thursday, July 23, 2015

The magic of limited liability

You find it obvious that if a company goes bankrupt, its owners don't lose their home nor become slaves. However limited liability isn't an old thing. While some exceptional bodies held it from the 15th century, it became common in the 19th. Before that if you defaulted on a business contract, you lost everything and even became slave (or locked into workhouses later).

No, it's not simply becoming more humane, like no longer cutting off the arm of a thief or whipping a vandal. These criminals are still facing corrective action (even if just sending to probation) and must repay the damage they caused. However those who default on their business promise are not only free of any corrective action, but the damage won't be repaid, even when the person(s) responsible for the damage are more wealthy than those suffering from it.

The question isn't about its morality, it's obviously not. The media is full of stories where businessmen and executors say "oops", fold the company and start a new, while investors and partners, usually little guys end up with nothing. The question isn't even about its economic value, it's obvious from the fact that every country (where private business can exist) introduced them, leading to economic growth. If limited liability would be bad, it couldn't spread. Remember, it's not an "it's always be the way" thing like the rejection of gay rights, the unlimited liability was the old way and it changed.

The question is why. Why does it work? Why is it a good thing to allow businessmen to practically scam people, offering them things, taking their money and then not delivering? The answer is anti-social: because it's good to scam dumb socials. If they were told the truth, they would keep their money and spend it on "fun" (personal well-being), which has zero value for the mankind. On the other hand their money in the hand of the businessman can increase the GDP, serving the mankind.

By being scammed into supporting various businesses, they become angel investors - without knowing it and against their will. I mean the honest way would be saying "Hi, I have this idea of company that might not work, but might do and then further the mankind. Please support me and in case I'd succeed, I'd return your investment." This offer works only on a few bored millionaires who are indeed angel investors. Instead the businessmen say "Hey dude, if you give me X money, I give you Y in return for sure, as written on the contract." When their business succeed, they indeed deliver. When it fails, they say "oops", go bankrupt, repay only what's assets left on the company and leave with their personal wealth to the next attempt.

Angel investors are a good thing, no one doubts that. The magic of limited liability is turning every social person into an angel investor, regardless if they like it or not. Sure, placing your money to the bank, buying a stock of a big company or paying in forward to a travel agency is less risky than being the sole supporter of a startup, but still, there is risk in it and this risk is fully on the one who put in the money, encouraging the businessman to go wild, as going wild sometimes lead to great things. And "sometime a great thing" is surely better than "let's get some beer and have fun", what social people would otherwise do with their money.

Why just social people are affected? Because they give the money just because some guy or company promises something nice and looks nice and trustable. The asocial approach is to evaluate the business model itself and ignore it if the evaluation fails/impossible (if you don't understand, don't invest). If the evaluation is complete and you fully understand it, then reject it for being bad, or willingly angel-invest it.

PS: look at this beautiful battle report between MoA and 3x blobbing SMA.
On a different note, I don't understand why BL is so smug about completely destroying an equal sized and shipped SMA fleet. Killing SMA on equal footing should be called "ratting".


Provi Miner said...

risk vs reward, a moments satisfaction vs a longer safety. There are many many reasons why we do what we do, the best that I can think of is you tell someone: Hey you know this could be the next new X (X here is some small start up that just sold for a billion dollars, example beats by dr dre every honest study says the same thing over priced under performing) or take corona beer every year after year it ranks near the bottom of every taste test yet stores can't keep it on the shelves? why? Cause they have one dam good advertising program. you have good advertising you can sheer any sheep.

Anonymous said...

> if you don't understand, don't invest

that's an interesting point ... but if everyone took that advice, how much innovation would have simply not happened?

Gevlon said...

@Anon, this is the point. People who are scammed into investing risky stuff helped innovation. It was against their interest, but at the interest of the mankind.

Anonymous said...

The one thing you do not mention, is that they do not only scam socials with money, but also small businesses. My father has his own company in the construction business and once wasn't payed for his work for 25M HUF (~85k dollars). Now he only works for other limited liability companies if they pay after every minor part of the job, if they do not sign a contract like this, he does not go into business, if they sign the contract and missed any of the payments, he gets his stuff and goes to other constructions.
Still that 25M HUF was a high price for this lesson.

Gevlon said...

Your dad was too trusting (=too social). Now he is not.

Anonymous said...

Dear Goblin. I seriously doubt your business expertise. Limited liability is good because it allows entrepreneurs to start risky businesses they would not be able to finance on their own. However, it is not designed to help scamming "angel investors". When you start a public company, in most civilized countries you have to publish a prospectus detailing all risks and opportunities for the company. If the founders deliberately lie in this prospectus they are personally liable for all losses of the investors and commit a criminal offense. For private investments there are less strict rules but rules nonetheless.

In most countries it is illegal to scam other people be they social or not.

Anonymous said...

I wonder about that BL fight with SMA.
For me it was not equal fleets at all.
BL have like 1/4 more members and like 100% more logi power!
Calculating SMA skills that actually looks like OVERKILL for BL.

Gevlon said...

"Limited liability is good because it allows entrepreneurs to start risky businesses they would not be able to finance on their own." = "placing the risk on someone else"

It is true that explicit lying is forbidden, however ordinary guys are completely unable to assess the risk of a company, and decide solely on social clues. In short "guy tells them it's a great business despite he knows otherwise", which is practically the definition of scamming. The only reason why it's not a legal scamming is limited liability itself: the partner is informed (as he must know) that in case of bankruptcy he is going down.

Anonymous said...

A company being run with any illegal practices can still wind up with legal action being taken against the owner, it doesn't restrict their liability that far.

As for why it exists and why it's a good thing? It's because it promotes business. When you create a limited liability company you still stand to lose everything you put into it, you're simply creating a new legal entity to protect your own personal assets. Otherwise the risk would be far too high for many small business owners to start a business as if they get competed out of the market and lose their business, they would also lose their house, their car, etc.

It's not about making it so that these small businesses can scam (and there's pretty strict rules in most countries that make that very difficult), it's about promoting business by allowing the business to hold the risks, not the people behind the idea.

The same thing happens when you buy insurance. You get a car and get it fully insured then you have a tire blow out and it veers off into a building causing millions in damages. You don't pay for that because you've put the liability for that on the company.

Gevlon said...

Except the liability in this case is transferred to people who don't expect it and can't assess it. When your salary is wired to your bank on Monday, you don't consider it's a risk to keep it there in a few days, despite it is. The bank might close and you lose access to your money (ask the Greeks) or you lose it completely (ask in Cyprus). Similarly when you sell a bunch of cement to a construction company with the payment deadline other than the minute they receive the cement, you usually don't expect it to be a risky investment (ask anyone in Hungary or just check comment #4).

The point is that if a company goes down, there is damage. Limited liability saves those from the damage who
- are the most responsible for it
- are the most likely can bear it (business owners are more rich than average people)

Anonymous said...

" If they were told the truth, they would keep their money and spend it on "fun" (personal well-being), which has zero value for the mankind."

As long as they spend money, they help driving the GDP up. Someone is still "manufacturing" or "providing" the "fun" that they consume.
Money being spent in an economy = good, doesn't really matter if its on ice cream or sports cars.
Your point was probably that investing that money in potential new businesses might be better for the growth (and RnD) in the long run, but someone will still have to consume the "fun" products that are produced.

Most people in the western world spend money on "fun", and not "necessary" (too lazy to find a source :P).
After all, is an iPhone "fun" or "necessary" ?

Gevlon said...

@Anon, let me answer with a Warren Buffet quote: "If I wanted to, I could hire 10,000 people to do nothing but paint my picture every day for the rest of my life. And the GNP would go up. But the utility of the product would be zilch, and I would be keeping those 10,000 people from doing AIDS research, or teaching, or nursing. I don't do that though"

Now replace "having a picture of me" with any form of fun activity.

Anonymous said...

Ah, but that would still be preferable to him not spending that money at all..
The whole reasoning there is pretty flawed. Out of those 10k ppl, how many would be eligible to do anything truly productive (AIDS research)? And for those that are, why would they then prefer to take his job offer? Unless he pays a lot more than the "product" is worth.. but that still puts money in 10k pockets, that will then be spent.
And the kicker.. why doesn't he pay those 10,000 ppl to do AIDS (or cancer) research instead of painting his picture? It is his choice, so the reason "I chose not to" says nothing.

Creating jobs is easy, there are literally no limit to the amount of jobs that can be created. However the trick is how you measure what is good for mankind.
Modern society is built upon spending, so is there "bad" spending? It all depends on how you view it, because no money spent (even on the dumbest shit imaginable) goes into a black hole, it goes back into circulation. If no money circulate, we get an economic cardiac arrest.

Does Buffet help the economy anyways by not spending that money? Of course, because most of his assets are not liquid, but in companies and real estate.

Anyways, back to exploiting slackers.
Keep blogging!

Gevlon said...

Buffet donates that money for causes he supports.

We don't know what is "good" spending but we know for sure that "fun" is as bad spending as possible as it creates no tangible product or increase the productivity of anyone. Of course it doesn't mean it should be banned, it cannot (see alcohol ban). But any trick that makes people spend better than that is welcomed.

maxim said...

Limited liability is good because it allows people to control how much they risk in their endeavours. With limited liability, your only risk is your own personal time. Without it - people who only have time and not wealth they could risk wouldn't be able to participate in any capacity at all. Now they get to participate, so more people participate.

That is the entire justification of limited liability. It doesn't have more justification and doesn't need more, frankly.

You are trying to go one step further and say that entrepreneurs that scam people are justified in breaking of promises. Breaking of promises can only be justified if the person that received the promise forfeits it. There really is no other instance in which it is okay.

You are also stretching the definition of angel investor a lot. If i spend my money with intent that is not angel investing and then they get used for angel investing, then i don't see how it makes me an angel investor.

If you are saying that my intent is irrelevant because i'm a social and you know better, then my answer is that you really don't, please go away and stop defending people who promise me stuff, sign contracts with me and then fail to deliver.

Well, unless you are willing to go ahead and separate people in two groups, one the promises to which are worth keeping and one the promises to which are not worth the paper they are written on. Are you willing to go down that road?

Gevlon said...

@Maxim: limited liability doesn't decrease risk, merely transfer it to others.

EVERY default is a broken promise.

Anonymous said...

"The question is why. Why does it work? "

Because there's things called BANKS which do due diligence and don't lend to bad prospects or outright scams, and even if they do it's written off from profits and account holders still get their money back. The people you are talking about, who throw money into dot coms and other crap, barely even factor in.

Now you can possibly make a point that everyone is ultimately scammed, via the banks being bailed out by the government when this system fails, but that's extending the topic a bit.

maxim said...

A risk shared is a risk reduced.

And yes, every default is a broken promise and shouldn't be encouraged or facilitated.
Right to make mistakes doesn't mean the right to make mistakes at the expense of people who didn't explicitly signed on to share your risks.

Mirkali Maricadie said...

And that's why many investment contracts have a great number of stipulations. As someone who's been on the small startup end, I can tell you that investors like to have a lot of their money go to assets as that's something that can be readily reclaimed if everything goes "tits up". Of course, with the multitude of public quasi-investor options now (kickstarter especially, with practically no protection), the scenario you descibe is likely to become much more common.

Hanura H'arasch said...

@maxim: "That is the entire justification of limited liability. It doesn't have more justification and doesn't need more, frankly."

That's like saying the only justification for having sex is producing children. It might even be true for devoted Christians, but it simply misses the point.

"If you are saying that my intent is irrelevant because i'm a social and you know better, "

Your intent is rationally irrelevant for anything but predictions of the future. Ask any driver who overrun a child with 80 km/h in a 30 zone, I'm sure they will convincingly tell you it was never their intention to cause an accident. But they did, they killed the child just the same as some murderer, who did the same on purpose. The only difference is the driver is vastly less likely to repeat it.

Gevlon said...

@maxim: no, the shared risk is a reduced risk for you and increased for someone else

@Mirkali Maricadie: the point is that limited liability makes every contract and investment contract, even a simple "I buy a car from a dealer" contract. When you give him the 10% pre-payment, you believe that you gave 10% pre-payment, but actually you invested into his business and he is entitled to use your money for everyday operational cost and if he goes bankrupt before your car is delivered, you are out of luck.

maxim said...

You seem to put a really low premium on the future. Both predictions and children.
I'd rather not see the society i live in constructed in a way that makes future an afterthought

Your example with the driver is flawed, because in the scenario of me preordering something and crashing, i am not the one at the wheel. Rather, i am the one lead to believe that this is a safe place to cross/play when it wasn't.

You are implying that the sum of risk is the same. It is not, it is actually lower.
Though then the question is how exactly you are measuring the risk - as a raw sum of money being put of the line, or as a mathematical expecation where sum of money and probability of losing it are both considered. I can see how sum of money would be the same, but then i cordially invite you to my casino, where i am ready ten times what you bet (just let me doctor the odds first).

Also in your answer to Mirkail, you are missing a very important point. Investment buys me a part of business and a measure of decision power. Prepayment doesn't buy me that and is therefore not an investment.

If you want to treat it as an investment, then it is not an investment in the company, but rather an investment in the project of creating the thing i preordered, where me and the the recipient of prepayment are both partners. However, in this instance i don't care if my partner bails out because he has financial issues elsewhere. He bailed out and should be punished accordingly - if not by law, then by me telling far and wide how sucky of a partner he is.

Hanura H'arasch said...

@maxim: I too, value the future. I don't know what makes you think otherwise.

"or as a mathematical expecation where sum of money and probability of losing it are both considered."

But both the sum and the probability don't change, so why would sharing the risk suddenly reduce the total risk? (and if it did, why don't we share every risk among everybody, should nearly reduce the risk to 0, shouldn't it?)

"Investment buys me a part of business and a measure of decision power. Prepayment doesn't buy me that and is therefore not an investment."

While being a nice side-effect of buying shares, an investment is just the action of putting a resource into something with the expectation of achieving a profit. It doesn't matter if you get any decision power, it's still an investment.

", then it is not an investment in the company, but rather an investment in the project of creating the thing i preordered, "

You cannot invest into a project, only in the legal entity behind it (the company). And investing into a company is a risk, one that you bear. And unless they explicitly lied to you, I don't see any reason why they should be personally punished when they bail out, as you knew there was a risk involved.

maxim said...

If you valued the future as it deserves, you wouldn't say that interpreting sex in terms of children is "completely missing the point". The point of sex is children, everything else is just fluff nature put there to bait us into the process - much like a game designer puts rewards around the core loop of the game. The fact that we learned to cheat the design to the extent where some deeply confused people start thinking the fluff is the point is kinda irrelevant.

You also seem to be confused on what is an investment and what can one invest in. You start by defining investment as an action with intent of profit (correct, but incomplete definition), but then you say that prepurchase is an investment. What, exactly, is the profit that you get out of prepurchase? Especially if you prepurchase something that's not exactly enduring, like a modern computer game?
Then you are saying that you can only invest in a company. What about people investing, say, in a piece of art? Or in their own education?

Finally, you are saying that it is perfectly okay for companies to fail prepurchases, because caveat emptor apparently. And that the people who bailed out should not personally suffer. Well, they should suffer, because they wronged people who relied on them as they bailed out. The extent to which they should suffer is debateable, but no get-out-of-jail free card here. There should be a reputation hit at the very least.

maxim said...

Also, a risk with two sets of human eyes of it is always smaller than a risk with one. Humans, being active observes, inherently have that impact on chaotic quantum space.

Hanura H'arasch said...

"If you valued the future as it deserves, you wouldn't say that interpreting sex in terms of children is "completely missing the point"."

I suppose that's because it didn't say that in the first place. I said it's not the only justification. I can have sex with my only justification of having fun, while using birth control and abortion (just as many people do). But saying that other people's justifications are nonexistent misses the point (as long as the justifications themselves are actually valid).
As a side note, just because biology wants you to have children doesn't mean you have to obey. Your are the the master of your own destiny. And as such, you can choose to do more valuable stuff than producing children while still reaping the rewards of sex.
Also, you imply that biologically producing children = good for the future, but that's not really true, as earths population is still growing significantly.

"What, exactly, is the profit that you get out of prepurchase? Especially if you prepurchase something that's not exactly enduring, like a modern computer game?"

Depends on the actual situation, games for example generally have bonus levels, vanity stuff or even DLCs. Buying a brand new car from a dealer might only possible by paying something before hand, or it might be cheaper.
Profit can be quite abstract, but in any case there must be something or you wouldn't do it in the first place.

"Then you are saying that you can only invest in a company."

Again, no, I said you cannot invest (money, if that wasn't obvious from the context) into a project, only in it's makers. There are simply no laws that would make it possible to invest money into a project, a legal entity is always required. That legal entity could be you as well of course (which is why I put company in braces) but then bailout would be non-issue.

"Finally, you are saying that it is perfectly okay for companies to fail prepurchases, because caveat emptor apparently."

No, the company should be punished for failing pre-purchases, and they are as all assets of the company are seized, sold and distributed among the creditors (which also disqualifies it from being a case of caveat emptor). I'm merely saying that the leaders of the company shouldn't be punished personally by law. After all, they did lose their invested money and time as well, and they wouldn't have started the company if they didn't think it would work out.

dobablo said...

Deliberately running a company as you suggest is fraudulent. Deliberately entering contracts without the intention to service their requirements can be punished with the offender being banned from owning or holding company office.

Limited liability law is very powerful and because of this it has a number of safeguards to prevent persistent abuse. A limited company that offers no services and exists with the intention of fleecing investors can be dissolved into a sole-trader and the owner would be liable for business debts.