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Liquidation is a financial and business term. Do you know what it means? Let Bankrate explain.

What is liquidation?

Liquidation is the process whereby a business closes and its free or unpledged assets are sold off. The proceeds are then used to pay the business’ debtors. A company may engage in massive stock liquidation, especially if it wants to cover a lot of existing debts before closing its doors for good. After the creditors are settled, any remaining amount is divided proportionately among the company’s shareholders, according to their shareholdings.

Deeper definition

In finance, liquidation happens when a company becomes insolvent, meaning it cannot settle its debts and obligations. Liquidation is normally done voluntarily by the shareholders or as a compulsory process done by creditors, following a court order.

Voluntary liquidation occurs when there is an agreement among all shareholders of a company. The shareholders hold a referendum where they vote to decide whether liquidation should take place. The company then liquidates its assets and frees up its funds to settle any debts. Voluntary liquidation can also be as a result of the main shareholder leaving a firm. The other shareholders can then decide not to continue with the firm’s operations, paving the way for liquidation.

A compulsory liquidation happens when a court orders that a company’s assets be realized and then distributed among the company’s creditors. The procedure starts with the filing of a petition in court. The judge handling the petition then decides and makes a ruling on whether it is appropriate to order a liquidation. When the liquidation is done, the company begins the process of dissolving.

In a compulsory liquidation, a petition is often filed by a creditor. However, the directors, shareholders, or even the company itself can seek to have a company put into a compulsory liquidation.

Liquidation example

When liquidation is carried out and a company closes, there can be several advantages. Outstanding debts are written off, providing an opportunity to move on rather than having the entire investment swallowed up by existing debts.

If legal processes have been initiated by creditors, the process of liquidation halts them, terminating legal actions against the company. Another advantage is that leases and purchase agreements can be canceled. The companies making such claims can recover their investments from the insolvency practitioners, together with other creditors.

With liquidation, all business assets are sold off to settle all debts. This means there will be no remaining assets to start a new business. Thus, all the staff members will have to look for other employment. And if a new business proposal comes up, a new process will have to be initiated to find new staff members. This process is tiresome and costly, since the company will have to start from scratch.

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