Assets upon liquidation

What happens when a publicly traded company runs out of money? If a company can no longer pay its obligations (similar to not being able to pay your mortgage), it may end up in bankruptcy court. In bankruptcy, the court can require the company to go through a liquidation of its assets.

A liquidation is the sale of all company assets, including buildings, factories, inventory, equipment, and vehicles. The company sells what it can to pay its creditors (entities it owes money to). If anything is left after creditors are paid, stockholders may receive a payout - but you’ll see why that’s uncommon.

Here’s the order of payout during a company’s liquidation:

1. Unpaid wages

2. Unpaid taxes

3. Secured creditors

4. Unsecured creditors

5. Junior unsecured creditors

6. Preferred stockholders

7. Common stockholders

There can be some confusion about the order of unpaid wages and taxes versus secured creditors, depending on the source. Secured creditors have first rights to the collateral backing the loan. The liquidation priority above applies if the collateral backing the loan is liquidated and does not cover the loan balance.

To see why, assume a secured creditor is owed $1,000, while $100 of wages and $100 of taxes are outstanding. If the collateral backing the secured loan is liquidated for $600, that $600 goes to the secured creditor, reducing the loan balance to $400. Next, the rest of the company’s assets are liquidated for $500. $100 goes to unpaid wages, $100 goes to unpaid taxes, and the remaining $300 goes to the secured creditor. This leaves the secured creditor with $100 still unpaid.

The order of unpaid wages and taxes versus secured creditors is not heavily tested. Exam questions are much more likely to focus on the priority of creditors (bondholders) versus equity holders (stockholders).

When a company liquidates, it pays claims in priority order. It starts with unpaid wages, then unpaid taxes. Next, it attempts to repay secured creditors.

Secured creditors have loaned money to the company, and their loans are backed by collateral (a specific asset). For example, with a mortgage, your home is the collateral for the loan. If you don’t repay the loan, the bank can take the house. In a corporation, secured creditors typically have a lien on a building, equipment, or other valuable corporate assets.

After secured creditors are paid, the company pays unsecured creditors if there’s money left. These parties lent money to the company but do not have a lien on any specific asset. These are essentially “full faith and credit” loans: promises to repay without collateral.

After unsecured creditors are paid, the company attempts to repay junior unsecured creditors if there’s still money left. The difference between unsecured and junior unsecured creditors is priority in liquidation. Both lent money without a specific lien on company assets (collateral). Junior unsecured loans are the riskiest type of loan for a creditor to make.

After all creditors are repaid, the company attempts to repay preferred stockholders if any money remains. Preferred stock is a different form of ownership, and it has priority over common stock in liquidation. That means preferred stockholders are repaid before any common stockholder.

Finally, after creditors and preferred stockholders are repaid, the company attempts to repay common stockholders - again, only if money remains. Most liquidations don’t raise enough to fully repay creditors, so stockholders (preferred and common) often receive little or nothing. Even so, they still have a legal claim to any remaining assets after higher-priority claims are satisfied.