What Is Liquidation?
The term “liquidate” refers to converting property or assets into cash or cash equivalents by selling them on the open market. Liquidation similarly refers to the process of bringing a business to an end and distributing its assets to claimants.
Liquidation of assets may be either voluntary or forced. Voluntary liquidation might be initiated to raise the cash needed for new investments, purchases, or to close out old positions. Forced liquidation may be employed during bankruptcy procedures, where an entity chooses, or is compelled by a legal judgment or contract, to turn assets into a liquid form (i.e., cash).
Liquidation can also refer to selling off inventory, typically at steep discounts. It may occur without filing for bankruptcy when a company chooses to clear out old inventory to make way for new items.
Key Takeaways
- “Liquidate” means to sell an asset for cash.
- Investors liquidate investments for reasons such as needing cash, exiting a weak investment, or consolidating portfolio holdings.
- Liquidation can be voluntary or forced, especially through bankruptcy processes or margin calls.
Understanding Liquidation
In investing, liquidation happens when an investor closes their position in an asset. This action is often necessary when an investor or portfolio manager needs cash to reallocate funds or rebalance a portfolio. Poorly performing assets may also be partially or fully liquidated. An investor might liquidate assets for non-investment obligations like paying bills, financing vacations, buying a car, or covering tuition.
Financial advisors allocate assets with the goal and timeline in mind. For instance, an investor planning to buy a home in five years might hold stocks and bonds meant to be liquidated in that timeframe. The cash proceeds would then serve as a down payment for a home.
Margin Calls
Brokers may force customers to liquidate holdings due to unmet margin calls, which are requests for additional funds when a margin account’s value drops below a required threshold due to investment losses.
If the margin call is not met, the broker can liquidate open positions to restore the account to the minimum value, potentially without the investor’s approval. This action allows the broker to sell stock holdings in necessary amounts and without prior notice to the investor, possibly imposing commissions and holding the investor accountable for any losses incurred.
When Companies Liquidate Assets
Businesses can liquidate assets for cash even without financial hardship, but most business world asset liquidations occur during bankruptcy proceedings. Financial hardship can lead a bankruptcy court to order compulsory liquidation if the company is insolvent.
Secured creditors would claim assets pledged as collateral before the loan approval, with unsecured creditors paid from remaining liquidation funds. Any remaining funds after debts settle go to shareholders according to their share proportions.
Not all liquidations result from insolvency. Voluntary liquidation, initiated by shareholders believing the company’s goals have been achieved, appoints a liquidator to collect assets, liquidate them, and distribute proceeds accordingly—first to employees owed wages, then to creditors, and any remaining cash goes to preferred shareholders before common shareholders.
What Does It Mean to Liquidate a Company?
Liquidating a company involves selling all of its balance sheet assets to pay debts and dissolve the company. This process winds down the business’s affairs and distributes remaining assets to creditors and shareholders, if anything remains. Liquidation may be necessary if the company cannot meet financial obligations, has unmanageable debt, or is insolvent. Insolvent companies may undergo a Chapter 7 bankruptcy proceeding, which is often the best option for unprofitable businesses with no turnaround prospects.
What Happens to the Employees and Shareholders of a Liquidated Company?
When a company undergoes liquidation, it stops operations and employees generally lose their jobs. Employees are still entitled to receive unpaid wages and benefits, which come from liquidation proceeds. Additionally, they might claim unemployment benefits from the government while receiving these wages.
Creditors are repaid first from the liquidation process, then preferred shareholders. Only after these parties are fully paid does any remaining value reach common-stock shareholders, typically resulting in pennies on the dollar, if any.
Why Might an Individual Liquidate Assets?
Individuals liquidate assets like property, stocks and bonds, collectibles, and personal belongings to pay debts or generate cash. This method quickly raises funds to meet financial obligations.
Reasons for liquidation include financial difficulties like mounting debts, job loss, or unexpected large expenses, such as emergency medical bills. Liquidation may also be required for divorce settlements or to fund large purchases like a home or business. Additionally, brokerage accounts might necessitate securities liquidation if margin calls can’t be satisfied.
The Origin of the Term ‘Liquidate’
The word “liquidate” has been in use since the 16th century, originating from the Latin word “liquidus,” meaning “to melt” or “make clear.” It later became associated with legal and financial contexts, referring to quickly settling debts, selling assets, and distributing proceeds as cash.
The Bottom Line
To liquidate means to sell assets for cash, often quickly. Liquidation can be voluntary to boost cash positions or mitigate risk, or it may be forced by brokers or bankruptcy judges. The term “liquidation” derives from cash being the most liquid asset. In Chapter 7 bankruptcy cases, a company’s assets are liquidated, and the company ceases to exist, often leaving shareholders with minimal returns.
Related Terms: assets, bankruptcy, margin call, financial advisor, portfolio management.
References
- Wiktionary. “Liquidate”.
