The liquidation process in business refers to the action of concluding a company’s activity and distributing its assets to its shareholders, creditors and other claimants. Liquidation typically occurs when a company is insolvent (which means that that it cannot meet its financial obligations as they become due) but may also occur for other reasons.
There are in fact three main types of liquidation process:
• Members Voluntary – where the owners of a business choose to discontinue operating the company for a range of reasons. In this case the company is not insolvent and is able to make payments on time.
• Creditors Voluntary – this occurs when the business owner foresees that the company cannot meet its obligations and decides to begin the liquidation process after consulting shareholders and receiving a majority vote (75% or more) to do so.
• Compulsory – where the company is unable to meet its financial commitments as they become due (is insolvent) and is required to cease trading and liquidate its assets.
During liquidation, the assets of the company are distributed according to the priority of the claims of its creditors with a trustee appointed to oversee the process. The claims with the highest priority for payment are held by secured creditors who have provided financing secured by collateral provided by the company. These creditors will seize the items put up as collateral and sell it to recoup money owed by the company. The sale of collateral often involves a large discount to its value because of the short timeframes involved in the liquidation process and where the proceeds of the sale do not cover the debt the creditor may also make a claim on any other assets the company owns to make up the shortfall.
The next creditors in line for reimbursement are unsecured creditors. These usually consist of bond holders, government bodies (such as the tax department) and employees (that are typically owed unpaid wages or other benefits). Because these creditors are unsecured they only receive a payment if there is any money left after the secured creditors have been paid.
Finally, the shareholders of the company will receive a share of any assets that remain (in the unlikely event that any are left when a company is insolvent). In cases where assets are available for distribution to shareholders, investors that hold preferred stock will have priority for payment over investors holding common stock.
