Does your business have several outstanding debts and no way to pay them?
Or are you looking to close down your small business and sell all the assets? Either way, I’m here to help!
Hi, my name is AJ! I recently sold my business for multiple seven figures and created Small Business Bonfire (SBB) to help other entrepreneurs!
Although my most recent company was a success, I’ve learned a lot from fellow business owners about the liquidation process and its potential benefits.
Are you ready to learn about liquidation and how it can help your business? Let’s dive in!
Key Takeaways
- Liquidation is when a company sells its assets to pay back creditors.
- Some assets include furniture, equipment, inventory, and even stocks.
- Consulting a tax professional and lawyer is best when companies pursue liquidation.
Liquidation Definition
The first step in answering the “What is liquidation?” question is understanding the word’s definition.
Liquidation is the process of selling a company’s assets to earn enough money to pay back creditors.
The final result of the liquidation process (usually) is the business closing.
Usually, liquidation occurs because a company cannot make ends meet (pay rent, bills, etc.), and selling assets is the only way to pay creditors.
How Liquidation Works
Let’s get into how the liquidation process works.
To make things simple, I’ll use a lemonade stand as a fictional company.
Imagine you’ve started a lemonade stand and bought tons of lemons, sugar, cups, and an excellent sign to advertise.
Despite your efforts, your lemonade stand isn’t producing a lot of cash flow.
As a result, you owe money to the parents (or your creditors in a real-life business) you borrowed from to buy your supplies.
If you can’t find a way to pay your parents (or creditors) back, you may have a garage sale and sell everything you bought for the stand.
Selling all your company’s assets is what we call liquidation.
You will use the money you get from the sale to repay your parents.
Then, after you sell everything and the money’s paid out, your lemonade stand is officially closed.
In this example, liquidation is quite a simple concept.
But in the real world, with big businesses, liquidating a business’s assets can become a lot more complex.
Why Would a Company Choose to Liquidate?
There are several reasons a small business owner may choose to liquidate assets.
For instance, here are some reasons a company will choose to liquidate:
- The business has too many debts to pay to credit card companies, creditors, etc.
- The business isn’t earning enough money to afford its expenses (rent, utilities, inventory, etc.).
- The owner doesn’t want to own and operate a small business anymore.
The most popular reason liquidation occurs is because a company owes several debts and cannot generate cash to pay them off.
Also, many people assume liquidation is always bad, but it’s not!
If a business owner wants to pursue something else, they may choose to liquidate their assets to have enough cash to pursue this venture.
What are Business Assets?
As previously mentioned, a liquidation sale involves a business’s assets.
But what kinds of assets exist? And how are they distributed during liquidation?
Below, I’ll cover everything you need to know!
Types of Business Assets
Some examples of assets a closing or bankrupt business can liquidate include the following:
- Inventory: Including works in progress, finished goods, and raw materials.
- Equipment: Including computers, copy machines, printing presses, forklifts, etc.
- Furniture: Including couches, office chairs, desks, TVs, etc.
Sometimes, instead of selling outdated furniture or equipment, a small business will donate them because there are small business tax incentives.
Distribution of Assets During Liquidation
After all the business’s assets are sold, the money earned is divided among the creditors.
However, creditors must take turns receiving their cut before owners or shareholders get any cash.
There are two main types of creditors:
- Secured creditors
- Unsecured creditors
Secured creditors are lenders with collateral from the business.
However, it’s essential to understand that the collateral differs from the liquidated assets.
After selling the collateral, a secured creditor uses the cash to cover the remaining loan.
In comparison, unsecured creditors do not receive collateral.
Some examples of these types of creditors include:
- Credit card companies
- The government
- Employees
These entities have claims to a company’s liquidated assets.
Liquidation of Securities
When people think of liquidation, they often think about bankruptcy and selling everything.
However, a business can sell only some assets, such as stocks or securities.
This process is called the liquidation of securities.
Therefore, businesses sell preferred stock, common stock, etc., rather than inventory, furniture, and other tangible assets.
Selling securities is an excellent option for companies with valuable stock that don’t have many tangible assets.
How Does a Business Pay off Creditors?
When a business must sell its assets, it must first pay the highest priority creditors.
There are four types of creditors:
- Secured
- Unsecured
- Stakeholders
- Business owner
Secured Creditor
As previously mentioned, a secured creditor has some collateral it holds of the business.
Therefore, this type of creditor has the right to sell the collateral, like a car, to cover the money the business owes them.
An example of a secured creditor is a bank that loaned money to a business to start a company.
Unsecured Creditor
An unsecured creditor doesn’t have any collateral.
Therefore, these creditors are one of the first to have a claim to the assets a company sells.
Stakeholders
Although stakeholders are unlikely to be involved in small businesses, it is possible!
In cases of inventory liquidation, stakeholders are entitled to the last portion of liquidated assets.
If a business has assets left after a forced liquidation, investors in preferred stock get the money first.
After that, the holders of common stock receive funds.
Business Owner
The business owner is the last person to be paid.
So, after all the creditors get the money that belongs to them, the business owner can pay themselves with the remaining retail value of what’s left.
However, in most cases, little money is left over after paying creditors.
How to Liquidate a Business
How do you liquidate a business?
While it may seem challenging, liquidation is easier following this four-step process.
Step 1: Talk to Your Legal/Accounting Team
Before doing anything related to liquidating your business, you must first speak to your company’s lawyer and accountant.
Also, you must inform your creditors that you will be liquidating your company.
Talking to your lawyer and accountant is essential because they recommend the best way to settle your debts and sell your assets.
Further, they ensure your business takes the proper steps throughout the process.
Step 2: Prepare Your Assets
The second step to liquidating a business is to prepare your assets for the sale.
Preparing your assets includes doing the following things:
- Inventorying all assets
- Determining their worth
- Finding potential buyers
Also, if your business has items like a car up for collateral, preparing these items for selling is critical.
For instance, if you put a car up for collateral, ensure it looks as best it can before selling it.
Preparing your assets in advance helps you ensure that you earn the most money possible!
Step 3: Work with an Appraiser
The third step in liquidating a business is to work with an appraiser.
Working with an appraiser means setting prices on each asset you sell to pay back outstanding debts.
A qualified appraiser ensures you accurately estimate the worth of your items.
Lastly, deduct each sale’s costs when determining your net sale income.
Step 4: Determine the Type of Sale
The final step is determining what type of sale your business will pursue.
For example, some of the types of sales include the following:
- Negotiated sales: These types aren’t common but are helpful when a business needs instant financial assistance. Some buyers include a company’s competitors, suppliers, or landlords.
- Consignment sales: Sellers turn to a local dealer who sells items and then pay the business afterward.
- Internet sales: Selling assets on the Internet is common; just be sure to understand the rules and legalities.
- Sealed bid sales: These sales are helpful if confidentiality is critical. Buyers submit bids via a sealed envelope at a specific time and place.
- Going out-of-business sales: When your company has a big sale to attract customers. The goal is to sell as many items as possible.
- Public auction sales: Auctions are an excellent way to sell items quickly. To do this, you must hire an auctioneer.
Keep in mind that a business can pursue multiple types of sales!
Difference Between Liquidation and Bankruptcy
While both liquidation and bankruptcy involve financial distress, they are different.
For instance, liquidation is a process where a company sells off its assets to pay creditors, and it’s usually one part of the bankruptcy process.
On the other hand, bankruptcy is a legal procedure that allows an individual or a company to eliminate or repay some or all of their debts under the protection of the federal bankruptcy court.
Bankruptcy might involve liquidation, where assets are sold to repay creditors.
Still, it can also be a reorganization, where the debtor keeps some or all of their assets and operates under a court-ordered repayment plan.
In short, all liquidations could be part of a bankruptcy.
However, not all bankruptcies involve liquidation.
Each process has its implications and consequences, so it’s always advisable to consult with a financial advisor or attorney to understand what’s best for your situation!
Example of Liquidation
Here is an example of liquidation.
Consider a small, family-owned restaurant business struggling to keep afloat due to a downturn in the local economy.
Despite their best efforts, the owners cannot meet their financial obligations and decide to liquidate.
They first consult with their legal and financial team, which outlines the liquidation process and assists in informing creditors of their decision.
Next, the owners inventory all their assets, including the following:
- Kitchen equipment
- Furniture
- Inventory of food and beverages
- The restaurant premise (if they own it)
The company’s owners hire a professional appraiser who helps determine fair market values for each asset.
Once the assets are prepared for sale and appropriately priced, they decide on a public auction sale to sell off their investments quickly.
Further, they list their high-end kitchen equipment on the Internet to reach a broader market.
The proceeds from the sales are used to pay off their creditors, starting with the secured ones.
The unsecured creditors, like suppliers, are paid next.
Finally, after all the debts are paid, the owners divide the remaining money.
In this scenario, the owners might not get much, but they have successfully managed to liquidate their business, settle their debts, and move on to their next venture or opportunity.
Is a Company Dissolved After Liquidation?
A company is not automatically dissolved after liquidation.
Once the liquidation process is complete, the company’s legal existence ends.
This means that it no longer has any assets or operations but still exists as a shell.
At this point, it’s possible to dissolve the company formally by filing dissolution papers with the state where it’s registered.
It’s crucial to complete this step so that the company is no longer liable for any outstanding debts or obligations.
Closing Thoughts on Liquidation
Liquidation is when a business sells its assets to pay back creditors.
Businesses undergo liquidation because of a bankruptcy filing or the owner doesn’t want to run the company.
Whenever a company undergoes liquidation, it’s best to contact a tax professional and lawyer.
Are there any additional questions you have about liquidation? Let us know in the comments section below!