There are several scenarios where scheduling liquidation analysis makes sense for business owners. Here are some common examples:
- You’re planning to sell the business soon
- The business may be insolvent, or getting close to it
- Your company is preparing to acquire another business
- The company is involved in bankruptcy proceedings, or may be soon
Liquidation analysis provides a clear value of all of the company’s assets, including cash, accounts receivable, inventory, equipment, real estate and intellectual property (IP). It also tabulates the company’s liabilities, such as secured debt, credit card debt, payroll and taxes. By comparing the business’s assets and liabilities, decision makers get a clear picture of the organization’s overall financial health.
Signs That a Business May Be Experiencing Financial Distress
Liquidation analysis is primarily used to determine when a business has become insolvent or is dangerously close to becoming so. Insolvency analysis is required when restructuring debt, filing a bankruptcy reorganization plan, performing due diligence, when investigating fraudulent transfer claims or during litigation.
As a business nears insolvency, there will likely be signs that the organization is contending with financial distress. Those signs may include:
- A persistently negative operating cash flow (cash reserves deplete quickly)
- Delayed or missed rounds of payroll
- Reliance on short term debt to cover operations
- Declining business performance (dropping sales volume or gross margins)
- Creditors sending debt to collections
- Lien or repossession threats from regulatory agencies (unpaid taxes, for example)
- Frequent or unexplained accounting adjustments
- Legal judgments against the business
- Elevated executive turnover or mass layoffs
This isn’t a comprehensive list by any means, but these are some of the more common signs that a business is potentially insolvent. Liquidation analysis can confirm whether or not that is the case.
How Liquidation Analysis Services Can Help Prepare for a Business Sale
Liquidation analysis is a standard part of a business sale or other major business-related transaction. It provides benefits to both the buyer and seller, though the information is of particular value to the buyer. Here’s how the process supports a smoother sale:
- Establishes a baseline for the company’s value – Liquidation analysis provides a floor, or worst-case scenario for the company’s valuation, based on its recoverable assets. For the seller, this information provides a clear fallback plan should the proposed sale not go forward.
- Supports better due diligence – Liquidation analysis is a vital due diligence tool for the buyer. It can be used to determine which assets can be recovered or realized, and whether there are hidden costs that may reduce asset value.
- Improves positioning during negotiation – With a clear idea of what assets can be realized and at what rates, the buyer can evaluate their negotiation position with greater accuracy. For example, if asset recovery rates would be low, the buyer may request additional purchase warranties or even request a lower acquisition price.
- Helps creditors and lenders evaluate sale and payoff terms – Secured loans are typically protected by loan covenants that require lender approval before the business can be sold. Creditors are also extended this privilege in some cases, like during bankruptcy proceedings. Liquidation analysis provides lenders and creditors with asset recovery rates should the company default – an important consideration when approving the transaction.
- Assists with high level decision making – If business owners are unsure whether to pursue a sale or restructure debts, liquidation analysis can provide necessary financial insight.
Liquidation analysis can also help organize creditor repayment (by revealing lien issues) and can support better tax and regulatory planning (by reviewing numbers like purchase price). In summary, if you’re considering selling your company, liquidation analysis is a vital support process.
Liquidation Analysis is Also a Critical Part of Bankruptcy Proceedings
Liquidation analysis is typically requested by bankruptcy courts (or regulatory agencies) as part of the bankruptcy filing and reorganization process. Here’s how it’s applied during the process:
- Calculates recoverable assets for the purposes of repaying creditors – Liquidation analysis helps business owners develop repayment strategies – and it helps the court determine what would be in the creditors’ best interests. If liquidation would benefit creditors more, it may be enforced by the court.
- Supports better planning for Section 363 sales – Section 363 sales allow bankrupt companies to sell off assets in a special, often expedited auction process. Liquidation analysis confirms whether certain assets can be sold free and clear, and it helps frame the stalking horse bid.
- Prioritizes assets needed to preserve the company’s going-concern value – Liquidation analysis also reveals which high value assets are essential to preserving operations. This could be certain personnel, equipment or inventory, for example. Stakeholders can preserve these in order to maintain the company’s going-concern value, while liquidating expendable assets.
- Provides evidentiary support during hearings – During bankruptcy hearings, expert liquidation analysis can be admitted as persuasive evidence. This is particularly important when assessing plan feasibility or cramdown details.
Timing and Regulatory Concerns During Liquidation Analysis
There are a handful of regulatory and timing issues that business owners must keep in mind when performing or evaluating liquidation analysis. Some of these concerns can affect whether the analysis is applicable in real terms, and include:
- Automatic bankruptcy stays – As soon as a company files bankruptcy, creditors are no longer able to force liquidation. This can affect eventual asset recovery efforts.
- Fraudulent transfer claims – Attempts to transfer or conceal assets from creditors may be considered fraudulent, according to the Bankruptcy Code and state laws. Any liquidated assets may be clawed back if fraud is confirmed.
- Certain employment laws (WARN act) – Large headcount reductions or headcount reductions without sufficient notice may trigger employment laws. This may delay liquidation efforts and therefore impact the valuation.
- Lien priority – Lien priority determines which creditors are repaid from liquidation proceeds. Before assets can be sold, any liens must be cleared first, and this is a major factor involved in recovery.
- Environmental laws – If any assets (like real estate) are affected by environmental contamination, or if remediation of any kind is required (like removing asbestos or PFAS), this will also affect recovery efforts.
- Asset seasonality or obsolescence – If assets include seasonal inventory or soon-to-be-obsolete technology, it may be difficult to recover their full worth, especially if they must be liquidated quickly.
Again, these are only some of the factors that may affect the final liquidation analysis. As such, it’s highly recommended that business owners work with an experienced forensic accounting expert to perform their analysis.
Liquidation Analysis Provides Excellent Insight into Your Company’s Financial Standing and its Potential Value
Liquidation analysis is a time-tested approach to valuing a business – essential for major transactions and decisions. It’s useful for business owners, acquiring companies and bankruptcy courts, as it can detect insolvency and assess a company’s overall financial health.
Liquidation analysis is detailed process that must be done in an organized and process-oriented fashion. If assets are missed or wrongly classified during analysis, it will throw off valuation and put your decision making at risk. As such, liquidation analysis services should only be provided by an experienced forensic accounting professional as they have the methods and tools to ensure comprehensive and accurate asset valuation.
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