Liquidate

What Is Liquidate?

Liquidate means converting property or assets into cash or cash equivalents by selling them on the open market. Liquidation similarly refers to the process of bringing a business to an end and distributing its assets to claimants.

Liquidation of assets may be either voluntary or forced. Voluntary liquidation may be affected to raise the cash needed for new investments or purchases or to close out old positions. A forced liquidation may be used in bankruptcy procedures, in which an entity chooses or is forced by a legal judgment or contract to turn assets into a liquid form (cash). Liquidation can also refer to the process of selling off inventory, usually at steep discounts. It is not necessary to file for bankruptcy to liquidate inventory.

Key Takeaways

  • To liquidate means to sell an asset for cash.
  • Investors may choose to liquidate an investment for a variety of reasons, including needing the cash, wanting to get out of a weak investment, or consolidating portfolio holdings.
  • In addition to voluntary liquidation, individuals and businesses can be forced to liquidate assets through the bankruptcy process or by one's broker in response to a margin call.
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Liquidation

Understanding Liquidation

In investing, liquidation occurs when an investor closes their position in an asset. Liquidating an asset is usually carried out when an investor or portfolio manager needs cash to re-allocate funds or rebalance a portfolio. An asset that is not performing well may also be partially or fully liquidated. An investor who needs cash for other non-investment obligationssuch as paying bills, vacation expenses, buying a car, covering tuition, etc.may opt to liquidate their assets.

Financial advisors tasked with allocating assets to a portfolio usually consider, among other factors, why someone wants to invest and for how long. An investor who wants to buy a home within five years may hold a portfolio of stocks and bonds designed to be liquidated in five years. The cash proceeds would then be used to make a down payment for a home. The financial advisor would keep that five-year deadline in mind when selecting investments likely to appreciate and protect the capital for the investor.

Margin Calls

Brokers may force certain customers to liquidate holdings in event of an unmet margin call. This is a request for additional funds that occurs when the value of a margin account falls below a certain threshold required by their broker due to investment losses. If a margin call is not met, a broker may liquidate any open positions to bring the account back up to the minimum value. They may be able to do this without the investor's approval. This effectively means that the broker has the right to sell any stock holdings, in the requisite amounts, without letting the investor know. Furthermore, the broker may also charge an investor a commission on these transaction(s). This investor is held responsible for any losses sustained during this process.

When Companies Liquidate Assets

While businesses can liquidate assets to free up cash even in the absence of financial hardship, asset liquidation in the business world is mostly done as part of a bankruptcy procedure. When a company fails to repay creditors due to financial hardship, a bankruptcy court may order a compulsory liquidation of assets if the company is found to be insolvent. The secured creditors would take over the assets that were pledged as collateral before the loan was approved. The unsecured creditors would be paid off with the remaining cash from liquidation. If any funds are left after settling all creditors, the shareholders will be paid according to the proportion of shares each holds with the insolvent company.

Chapter 7 of the U.S. Bankruptcy Code governs liquidation proceedings. Solvent companies may also file for Chapter 7, but this is uncommon.

Not all liquidation is the result of insolvency. A company may undergo a voluntary liquidation, which occurs when shareholders elect to wind down the company. The petition for voluntary liquidation is filed by shareholders when it is believed the company has achieved its goals and purpose. The shareholders appoint a liquidator who dissolves the company by collecting the assets of the solvent company, liquidating the assets, and distributing the proceeds to employees who are owed wages and to creditors in order of priority. Any cash that remains is then distributed to preferred shareholders before common shareholders get a cut.