Liquidation is the process of selling off all the assets of an entity, settling its liabilities, distributing any remaining funds to shareholders, and closing it down as a legal entity. The liquidation process is a possible outcome of bankruptcy, which a company enters when it does not have sufficient funds to pay its creditors. A bankruptcy filing can be voluntary or involuntary. A petition to liquidate a company can be made to the applicable court by creditors who have not been paid by the company; if granted, the business will involuntarily enter bankruptcy.
If a business is being liquidated due to bankruptcy, then the funds raised are first used to pay creditors; if there is any cash remaining after creditors have been paid, the residual amount is distributed among the shareholders. The order of preference for being paid when an entity is liquidated (known as the priority of claims) is as follows:
- Secured creditors (senior position)
- Secured creditors (junior position)
- Unsecured creditors
- Holders of preferred stock
- Holders of common stock
The price received for a company's assets can be lower than expected if the sale is conducted on a rush basis. This is because the seller does not have sufficient time to locate the largest possible pool of potential buyers, so that the few buyers contacted can bid lower and still expect to achieve the winning bids. Consequently, a common outcome of liquidation is that no residual funds are left over to pay stockholders. This may also mean that there is not enough cash left to even pay creditors. If so, the secured creditors are paid first, and a reduced payout plan is used to pay any remaining funds to the unsecured creditors.