Definition: Liquidation is the process of selling off assets to repay creditors and distributing the remaining assets to the owners. In other words, liquidation is the process of closing a business, paying off creditors, and giving the investors whatever is left over.
What Does Liquidation Mean?
Businesses can liquidate their assets for any number of reasons, but the main two reasons are the company is failing and restructuring or investors want to leave the business.
Liquidations are far more common in bankruptcies and situations where the business is closing because it can’t support itself with revenues than any other instance. In a bankruptcy, the court generally takes control of the assets in order to sell them at auction to pay off the outstanding liabilities. In many cases, there aren’t enough assets to pay off creditors, so many of the unsecured lenders are out of luck. They won’t be repaid.
Liquidation does not always have to be company wide and under bankruptcy, however. Many businesses decide to close departments or merge with other companies. The unneeded departments and divisions are often closed with their assets sold or added to other divisions.
Occasionally, investors of partnerships and corporations want to leave the business or just receive a portion of their investment back. This situation is called a liquidating dividend. When the board of directors declares a dividend to shareholders without enough retained earnings or capital accounts to pay for the distribution, the company effectively returns some of the shareholders’ original investment. In other words, there isn’t enough cash from operations to pay investors a return on their investments, so some of the business assets are sold in order to give money to the investors.
Whether in a bankruptcy or a liquidating dividend, a liquidation is the same. The assets of a business are being sold and the company is shrinking in size.