What is Liquidation and How It Works
Defining liquidation
Business is like a game played by risk-takers. Just like any game, it may go uphill and, sometimes, unfortunately, on the rocks. In the challenging world of finance and economics, the term liquidation comes into the picture when this type of financial struggle arises, usually at the insolvency peak. The pricing of the general partner’s remaining assets or the faint quality items is at a lower rate than the business tagged – or significantly discounted. These compensate the claimants based on priority since the company or person is unable to pay. Let us take a peek at how the hierarchy unfolds:
The hierarchy of assets during distribution
During the distribution, an appointed trustee by the U.S. Department of Justice will supervise the whole process. As mentioned earlier, there is a priority in claimants. Let us enumerate the three:
(1.) On the top tier are the secured creditors. A credit product or collateral on loans tied up with the business backs up these lenders. With that said collateral, they will collect it with a massive discount given the limited time given to sell then go on with the company’s remaining liquid assets if it’s not yet sufficient.
(2.) Next are the unsecured creditors. Examples of unsecured creditors are the government or employees who were unpaid or the likes of bondholders.
(3.) Last are the shareholders. They are the recipients of whatever is left of the assets though in most cases, there aren’t any. But if there is still something left, preferred stock investors are first before common holder stocks, of course.
What is a General Partner?
Let’s say two or more owns and manages a joint business, one of them is called a general partner.
What do you mean by insolvency?
It is when a business or a person is struggling to make ends meet at the due date.
What is the difference between insolvency from bankruptcy?
A person becomes insolvent when the liabilities or debts are more than the assets – which only the IRS can state. On the other hand, bankruptcy is a filed verified court order that assesses how an insolvent, can and must sell remaining assets to pay off debts to lenders. In a nutshell, bankruptcy is a prolonged period of insolvency.
The U.S. Bankruptcy Code
Two chapters will further let us understand how liquidation works. Chapter 7 ultimately covers liquidation proceedings, and the ability to pay is ground zero. In contrast, chapter 11 reassesses and restructures the debtor’s assets and debts that still exist, giving it the name ‘reorganization. It is somehow like a rehabilitation on a business’s bankruptcy.
On another tone
In the securities discussion, liquidation may also refer to various acts.
- One is exiting or selling a position to obtain money.
- Coming up with a long position in shorting but with an equal number of shares is another way to talk about liquidation. This is an example of when you’re taking a similar but different role in the very same security.
A broker may be forced to liquidate a trader’s position because of inadequate records, failing to attain the marginal requirement, or recklessness.