Even in a bull market, some businesses struggle to make ends meet. Eventually, owners may decide to close the doors and liquidate a distressed company’s assets. If you're considering liquidating your company, understanding its true value is crucial. However, navigating the intricacies of distressed business valuation can be overwhelming.
Calculating liquidation value is quite different from valuing a business as a going concern, which considers its future profit potential. In contrast, liquidation focuses solely on the realizable value of its tangible assets after accounting for distress sale discounts. These discounts reflect the urgency of selling and the limited time available to find buyers, often resulting in prices below fair market value.
Outside financial experts can help owners make informed decisions about the distressed company’s future and maximize liquidation valuation. Experts can also help potential buyers of financially distressed businesses determine the appropriate asking price and conduct acquisition due diligence. Here are the details on these types of engagements.
One of the most important questions a financial expert can answer is: How much is the distressed company worth? Although business valuation experts typically calculate a company’s value as a going concern, certain financial trends – such as recurring net losses, declining sales, and severely reduced liquidity – may suggest that the business would be more valuable if it were liquidated. Generally, liquidation value is relevant when the company’s historical and expected earnings don’t contribute incremental value beyond its net tangible asset value.
There are two types of liquidation value, according to the International Glossary of Business Valuation Terms:
Generally, orderly liquidation leads to a higher overall recovery for the business and its stakeholders. However, it requires careful planning and execution, and may not be feasible in all situations. While forced liquidation provides some cash quickly, it typically results in a substantial loss compared to orderly liquidation. It's often a last resort used when other options are exhausted. Timing, bankruptcy laws, and judicial mandates all help a valuation expert determine the appropriate premise of value.
Liquidation value often serves as a “floor” for business value. It also can help owners decide whether to file for Federal Bankruptcy Code Chapter 7 (liquidation) or Chapter 11 (reorganization). In addition, it helps stakeholders evaluate the viability of spin-offs and mergers, out-of-court loan workouts, management buyouts, and reorganization plans.
When estimating liquidation value, experts typically start with the balance sheet. The book values of liabilities generally are accurate, but assets may require adjustments to estimate recoverability and current market values. For example, a distressed company may expect to receive 50 cents on the dollar for inventory and 70 cents on the dollar for receivables reported on the balance sheet.
Experts also must consider the existence of unrecorded items, such as patents, trademarks, customer lists, claims for back taxes, warranties, and pending lawsuits. If a company decides to liquidate, the expert must factor in liquidation expenses, such as lease obligations, severance pay, and professional fees. Usually, money is set aside in an escrow account for these incidentals before the company distributes liquidation proceeds to creditors and investors.
Alternatively, business valuation professionals can help buyers of distressed businesses determine their targets’ strategic value – or value based on the specific buyer’s investment requirements and expectations. For example, a buyer may be willing to pay more than the liquidation value for a company that provides synergies, economies of scale, or expanded market share.
Beyond valuation, financial experts can advise distressed businesses on such issues as negotiating debt restructuring with creditors and coordinating bankruptcy filings. They can provide fair opinions for management buyouts and third-party acquisitions and help implement reorganization plans. Business valuation experts also might work with, or serve as, court-appointed receivers and turnaround consultants.
When creditors file fraudulent conveyance lawsuits, valuation experts can help determine the facts by performing a solvency analysis. The expert’s subsequent solvency opinion determines whether the allegedly fraudulent transfer has left the company unable to service its debt obligations or continue normal business operations.
A distressed business often needs an expert who specializes in bankruptcy consulting. When evaluating a potential candidate, assess the expert’s financial expertise and knowledge of bankruptcy law, as well as his or her communication skills. Strong communication is essential when it’s time to negotiate with investors, creditors, and other concerned parties. Speak with a Meaden & Moore expert today to learn more.