When a business is no longer able to perform in full capacity, it decides to sell all its assets and turn it into cash.
There could be numerous reasons as to why a company is liquidating. With due valuation during the liquidation process, a business can sell off their assets to pay off its debt, pay the employees, and the investors. Essentially everyone who was somehow connected in the growth of the business who needs to be paid.
Through liquidation, the business is dissolved, and all the functioning stops. For businesses that have run out of funds, insolvency is the only option, through which they can pay off their debts.
The entire process of selling off assets is carried out in a period that lasts from 6 to 12 months. This period is still considered to be less because at large, various aspects related to the age, technological innovations, and the wear and tear associated with the asset will be looked at before the sale can take place.
- What is the Reason Behind Liquidation?
- What is the meaning of Liquidation Value?
- What is the issue with Liquidation Value?
- What is the good thing about Liquidation Value?
- What are the types of Liquidation?
The Reason Behind Liquidation
Insolvency is the biggest reason behind a business deciding or accepting that it will need to liquidate its assets. More often than not, you will find businesses filling for a legal petition stating that the company needs to be wound up.
There are a few situations, although, where a business might be forced into liquidation for the better:
- Debts keep on increasing since the business is not able to pay off the old ones.
- Failing to reregister the business as a private or a public entity, on time.
- The amount of debt has increased so much so that they now surpass the value of the business’s assets.
- The commencement of training has not been established in a set amount of time.
The Meaning of Liquidation Value
Standing different from book value, liquidation value stands at a place where if an asset does not have any book value, it could potentially still hold liquidation value.
So when exactly does this happen? The most common instance where you’ll notice this happening is when the assets of a business are subject to depreciation at an accelerated rate. Along with that, assets can hold liquidation value if the business has assets that can be appreciated but are not mentioned in the financial books of the company.
Then again, there is a similarity between the method used for liquidation valuation and the adjusted book value method, in which a market value is provided for every asset related to the business.
Amongst the two, liquidation value includes various other conditions and factors to valuation. In this method, it is assumed that the business has been unsuccessful and it is a must for the business to sell off all its assets immediately.
The liquidation value is determined by a professional who is qualified in the field of appraisers. They will provide the necessary information and an estimate with which a business can establish if they would like to declare that they will be closing up.
One of the major factors that will saw the liquidation value is the condition of the market at the time of the process of liquidation. When one business is going through a tough financial patch, the chances are that their industrial peers might be facing similar issues as well. This affects the price at which assets can be sold off, i.e. less than the best price. This enables other businesses to acquire assets at a cheaper price during drastic lows.
Here’s the Issue with Liquidation Value
Liquidation value is an asset-based valuation method, meaning it fails to consider the value of a business as an on-going situation that needs to be dealt with. This method also fails to assign a value to the intangible assets of the company since they do not have immediate comparable value in the current market.
Here’s the good thing:
It provides creditors with most of the useful information that they might require. Not just this, the liquidation value method is used by potential lenders to establish the business’s credit-worthiness for any future capital.
In cases of a secured loan, it can be observed that lenders and creditors are, at times, pressurized to liquidate the debtor assets. Essentially, liquidation value is of worth, and used, when a creditor’s position or priority needs to be determined.
Liquidation Types
To be clear:
- There are two types of liquidation values
- There are three categories for liquidation
Instances where the creditor is served a court order stating that it must take over the control of the assets of the businesses, it is known as foreclosure. Here, it’s the creditor’s responsibility to appoint a professional agent.
In another instance, i.e. voluntary liquidation, the business signs documents handing over the possession of the assets while ensuring that the lenders are being cooperated with. Both the parties, i.e. the lender and the debtor, try to make the process of liquidation as smooth as possible.
There also are situations where the liquidation is considered to be hostile since businesses can’t accept failure and have a fallout with the lenders. This leads to the debtors hiding crucial information from the lenders in an attempt to sabotage the entire process of liquidation. Without the possibility of deriving at a mutual solution, businesses are required to get authorities involved, creating a long trail of legalities.
No matter what the situation, liquidation shall be considered unsuccessful if the outstanding debts between the debtor and the lender are not settled.
For a business, liquidation value has been accepted to be a better floor price, against book value. In a situation where the price of a business goes down drastically, so much so that it would be impossible to take it out of the ditch, a corporate raider may come to the rescue. This raider may buy adequate stock, then liquidating the company, without the risk of a loss.
While taking into consideration the liquidation value of small companies, the financial books from the last 3 to 5 years should be taken into consideration, along with the functions of the company, the relationship it shares with its employees, competitors, and suppliers.
Rakesh Narula & Co. is a leading valuation consulting firm that offers its services to various niches. RNC’s blend of proficient and highly competent Technical and Commercial team facilitates Bankers and Investors to make suitable Lending / Investment Decisions. We provide techno-commercial services and valuation for current and fixed assets. Contact us now!