Net Asset Liquidation
The sale of a company's assets, followed by the end of operations.
What is Net Asset Liquidation?
The sale of a company's assets, followed by the end of operations, is known as net asset liquidation or net asset dissolution.
A company might undergo this process when it's struggling financially and can't pay off its debts to creditors.
To pay its creditors, who are the first to be paid in the event of a partial or complete liquidation of the company, the company typically sells off its assets on the open market to preserve the rights of its creditors.
Net assets are the difference between an organization's asset and liability values.
However, the money made from selling the net assets on the open market might not match their recorded book value. When a company cannot pay its debts, it typically sells its assets.
A voluntary divestiture plan to increase operational and financial efficiency is different.
Compulsory liquidation, also known as a creditor's liquidation or a receivership after bankruptcy, may result in the establishment of a "liquidation trust" by the court, or voluntary liquidation, also known as a shareholder's liquidation. However, the creditors govern some voluntary liquidations.
A corporation looking to sell part of its assets is frequently referred to as "going through a liquidation" informally.
For instance, a chain of fast-food restaurants might want to close part of its locations. To maximize efficiency, it frequently opts to sell assets at a loss to a company specializing in real estate liquidation instead of getting involved in a field where it might not have the necessary skills to operate profitably.
Types of Liquidation
A company that sells off its assets and then shuts down is said to be in net asset liquidation or net asset dissolution.
The value of a company's assets over its liabilities is known as its net assets. Nevertheless, the proceeds from the market sale of the net assets may differ from their reported book value.
There are different types of liquidation. Each procedure is used under specific circumstances, and the initial choice is whether the company is solvent or insolvent.
Total Liquidation
The procedure when a business closes down and is dissolved is known as total liquidation. According to the priority of their claims, all of the company's assets are allocated to lenders, creditors, shareholders, etc. After this procedure, the company no longer exists and is no longer a legal entity following the final liquidation.
Total liquidation can be enforced by the company's creditors or fully voluntarily by the company's management.
Partial Liquidation
Suppose a business has debt; it may be able to scale back operations and sell off some of its assets to cover the debt obligations. This process is called the partial liquidation process.
This is common for companies going through financial distress, which can use partial liquidation to pay a huge part of their debt to improve their financial situation drastically.
However, even after operating on a reduced scale, the company is still a legal entity. Again, partial liquidation can be either partially voluntary or partially creditor-induced.
Voluntary Liquidation
A company enters voluntary liquidation when it decides to stop operating independently. For example, the awareness that the company can no longer operate profitably may lead to the choice of voluntary liquidation.
For instance, a company that is having a hard time being innovative/competing in its industry might voluntarily liquidate its assets after anticipating that the market for its product/service demand would soon diminish.
Partial or full voluntary liquidation both fall under the umbrella of voluntary liquidation.
Liquidation Brought On By Creditors
In a creditor-induced liquidation, creditors of a company compel the company to shut down operations and sell off its assets.
The business's lenders may have lost faith in the company's capacity to repay the loans. As a result, if the company doesn't make its loan payments on time, the creditors may try to get their money back by making the company sell its assets.
The term "creditor-induced liquidation" refers to either full or partial liquidation caused by creditors.
Liquidation Induced By The Government
The government might intervene to totally or partially liquidate a company. These government-induced liquidations are justified by market reasons or something unrelated to the market.
To be clear, the government doesn't need to have a stake in the company to have the right to liquidate it.
We will take two examples of government-induced liquidation, one for market reasons and one for not. For illustration:
- For the stability of the economy: The government will oversee the liquidation of a bank if the bank is exposed to large amounts of risk and has reached bankruptcy. The reason is that banks are special institutions that affect all individuals in the economy.
- Environmental arguments: Suppose a company is emitting large amounts of waste/emissions and is not complying with the regulations set by the government. Then, the government might step in to reduce or end its operation.
- The government might induce partial or total liquidation.
Which Type of Creditors get paid first?
The highly specific order in which credits are paid was created to safeguard people who have a direct stake in the assets of the liquidated party.
A company's assets are distributed to its creditors in the event of liquidation according to a predetermined priority sequence.
Creditors who have secured claims on assets are given priority because these claims are frequently backed by collateral and contracts.
As some unclaimed creditors, such as employees and tax agencies, are given precedence, unsecured creditors are classified into preferred and non-preferred categories.
As a result, shareholders frequently get proceeds last in line, with preferred stockholders receiving preferential treatment over regular stockholders.
Now we will give an example of a creditor-induced liquidation to illustrate how net asset liquidation works:
During the COVID-19 pandemic J-Crew Inc., an American clothing retailer, filed for bankruptcy protection, planning to give control to the company's lenders, adding to the list of conventional retailers who have been driven to the breaking point by the widespread store closings brought on by the COVID-19 outbreak.
The New York-based firm agreed to get rid of $1.65 billion debt in exchange for giving lenders ownership of the company. According to court documents, the conditions of the proposal will result in the cancellation of around $2 billion of the retailer's entire debt and the exchange of approximately 82% of its stock.
Significant amounts of J. Crew's senior debt are held by Anchorage Capital Group, Blackstone Group Inc.'s GSO Capital Partners, and Davidson Kempner Capital Management, which are in the position to acquire the company's controlling interest.
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