Liquidation value is the amount at which a company could sell its assets and settle liabilities on a rush basis. The concept applies to the valuation of a business that is considering entering bankruptcy protection.
There are two variations on the concept that can result in different liquidation values:
- Orderly basis. The liquidation event is conducted on an orderly basis, where the seller spends a limited amount of time researching and evaluating possible buyers and their offers.
- Forced basis. If the liquidation event is forced, such as via a one-day auction, the value obtained will be lower than would be the case with an orderly sale.
The liquidation value concept can be extended to be net of liquidation costs, such as the fees charged by any third-party liquidation service hired to handle the sale.
No matter which of the preceding liquidation valuation methods is used, the calculated amount will be less than fair market value, because the sale transaction does not encompass a sufficient amount of time to make the sale visible to all possible buyers. If more buyers had been made aware of the sale, they might bid asset purchase prices up to higher levels.
Liquidation value can also be compared to the market price of a company's stock. If the market price is lower than the liquidation price, a reasonable assumption is that investors have no confidence in the ability of management to improve the prospects of the business. A possible alternative in this situation is to liquidate the company and return all residual cash to investors; this may represent the best possible return to the investors.
Another use of liquidation value is to use it as the lowest-end estimate of the value of a business that an acquirer wants to purchase. Though the price paid will probably not be the liquidation value, this does establish the bottom boundary of likely bid amounts.