Liquidation in finance and economics is the process of winding up a company and distributing its assets to creditors and shareholders. It typically occurs when a business is insolvent and unable to meet its obligations as they become due. As company operations cease, priorities define how the remaining assets are disbursed.
The term liquidation can also refer to selling underperforming goods at below-cost or undesired prices.
Key Takeaways
- Liquidation involves ending a business and distributing its assets to claimants.
- Once liquidation concludes, a bankrupt business ceases to exist and is deregistered.
- Typically, liquidation occurs during the Chapter 7 bankruptcy process.
- Priority governs the distribution of assets, favoring creditors before shareholders.
- Liquidation can also refer to selling off inventory, often at significant discounts.
How Liquidation Works
Chapter 7 of the U.S. Bankruptcy Code governs the liquidation proceedings. Although solvent companies may file for Chapter 7, it is uncommon. Not all bankruptcy cases involve liquidation; for instance, Chapter 11 bankruptcy centers on reorganizing the company and its debts, allowing continued operation afterward.
In Chapter 11, obsolete inventory might be liquidated, underperforming branches closed, and debts restructured. Unlike individuals, businesses do not erase debt post-Chapter 11, leaving the debt unresolved until the statute of limitations expires.
Distribution of Assets During Liquidation
A Justice Department-appointed trustee administers the liquidation process, prioritizing claimants. Secured creditors, having collateralized loans, possess the top claim. They often seize and sell collateral (usually at discounts) and seek remaining balances from liquid assets. Unsecured creditors, including bondholders, government (for unpaid taxes), and employees (for unpaid wages), follow. Shareholders are last, with a slim chance of recovering any leftover assets.
Liquidation of Securities
Liquidation also means converting securities into cash—by selling positions or taking an opposing stance (e.g., short-selling corresponding to a long stock position). Brokers might forcibly liquidate a trader’s holdings below the margin requirement or if risk appears mismanaged.
Example of Liquidation
Consider Company XYZ, a decade-old, formerly profitable business now unable to meet debts or expenses due to economic downturn. XYZ opts for Chapter 7 bankruptcy, selling assets like a warehouse, trucks, and machinery valued at $5 million. It owes $3.5 million to creditors and $1 million to suppliers. The liquidation proceed will cover these obligations.
What Is the Liquidation of a Company?
Liquidation happens when a company sells assets to meet financial obligations and possibly ceases operations. Bankruptcy and courts often estimate and distribute recovery value among creditors.
What Does It Mean to Liquidate Money?
Liquidating assets is converting them into cash, like selling a house, car, or other property. Assets’ liquidity is measured by convertibility ease—houses (less liquid) versus stocks (more liquid).
Is a Company Dissolved After Liquidation?
Liquidation and dissolution differ; liquidation addresses asset distribution to claimants, while dissolution is the company’s official deregistration.
The Bottom Line
When businesses become insolvent, they undergo liquidation to meet financial obligations. This involves closing operations and asset distribution by priority, applied in securities exit strategies too.
Related Terms: bankruptcy, insolvency, asset liquidation, secured creditors, Chapter 7 bankruptcy.
References
- United States Courts. “Chapter 7 - Bankruptcy Basics”.
- United States Courts. “Chapter 11 - Bankruptcy Basics”.
- U.S. Securities and Exchange Commission. “Bankruptcy: What Happens When Public Companies Go Bankrupt?”
- U.S. Securities and Exchange Commission. “Stocks”.
