Businesses are liquidated all the time and for a variety of reasons: It’s no longer viable; there is no buyer for the assets as a going concern; there has been a successful asset sale of the business but the old legal entity still exists; etc.
Whatever the reason, there are all sorts of traps, hidden and otherwise, that can ensnare a business owner along the way. In today’s newsletter, we talk about uncovering, avoiding and minimizing the impact of these dangers.
The three basic steps to take in a liquidation are:
- Thoroughly assess the situation (the most important step).
- Decide whether to liquidate or simply abandon the assets to creditors.
- Execute the liquidation.
Let’s consider each step in turn…
Thoroughly Assess the Situation
#1. Calculate the runway.
In other words, when will the company run out of cash? This is done by
completing a 13-week cash flow
. Unless additional funds can be found, the liquidation must be complete before the money runs out.
#2. Size up the creditors.
Which are secured (and by what) and which are not? Have a UCC (Uniform Commercial Code) search run for all of the company’s locations, to be sure you know which creditors are really secured.
When evaluating creditors,
don’t consider just the obvious: lenders, vendors and landlords. Payroll and payroll taxes, for example, can be an ugly surprise; you need to pay all employees’ wages that are due. That often includes unused vacation, guaranteed bonuses and more. The definition of “a wage” is a function of relevant state law and any employment agreement, so engage counsel versed in these matters for each state. Along with wages comes fiduciary tax withholding — generally, payroll and sales taxes. Typically, for both wages and fiduciary taxes, Directors, Officers and responsible parties are
personally on the hook.
The other bogeyman creditor sometimes lurking is the Pension Benefit Guaranty Corporation (PBGC), the Federal agency that guarantees pension plans. Is your plan underfunded? Expect the PBGC to chase you down for the shortfall. For example, in one liquidation I worked on, the PBGC threatened to seize the portfolio companies of the private equity firm that owned the company. In another, they hunted down a wealthy individual.
#3. Review relevant documents and look for guarantees and co-borrowers.
Guarantees can be from related entities or individuals (perhaps you) and designate those who are liable for making up any shortfall for a particular creditor. Make sure as well to look for collateral
outside of the business that secures a loan or other obligation. For example, SBA loans often come with a mortgage on the owner’s house. Sometimes, the business loan has a mortgage on related real estate. As mentioned earlier, the PBGC will often go after owners for recovery.
#4. Evaluate assets.
Which of these can be liquidated and which have liens on them? Be realistic about value — assets typically realize much less than you think (click
for more on why).
Also, look for valuable “
,” such as brand names, patents, customer lists, domain names and more. In one instance, I liquidated a scrap metal company during a period of high metal prices. Management found a way to scoop up the top several feet of dirt in the scrap yard and extract quite a bit of metal!
#5. Consider “burial costs.”
in a previous newsletter
, final tax returns,
D&O “tail insurance”
and record retention are additional, potentially major items that need to be considered. Also, make sure all employee benefit plans are terminated and funds set aside to file the final paperwork with the Department of Labor.
Decide Whether to Liquidate or Abandon the Assets
all assets should be abandoned.
More often, however, it’s best to decide asset by asset.
Why abandon everything? Recently, I learned of a company that owned five restaurants in Manhattan. Management and the owners determined that these could not operate profitably until at least two years post-pandemic, when New York City returns to “normal.” Ownership had not guaranteed any obligation, so all employees were let go and paid, burial costs were funded, and minimal cash was left in the bank. Landlords and creditors were left to sort through the mess on their nickel, not the owners’.
Most of the time, however, it makes sense for the company to drive its own liquidation. For smaller businesses in particular, owners often have personal guarantees and so it is in their best interest to maximize the recovery for those debts. Also, since creditors typically have no obligation to pay wages, fund burial costs, or cover unpaid fiduciary taxes (unless government liens have been filed), Directors, Officers and owners can be on the hook for these.
More often, abandonment is an asset by asset decision.
The essential question to be answered is whether the recovery will exceed its costs. Besides the direct costs of recovery, there is the time factor, and there are always ongoing costs while a business continues to operate.
If management is emotionally invested in an asset, there is a great tendency to overstate its value. For example, I liquidated a failed financial services firm that had spent a lot of money developing a proprietary securities trading software and collecting extensive and unique market data. Even after a failed sale process, equity thought the software and market data was worth lots. So much so that they expected its sale to pay all creditors and return some capital. In reality, the software didn’t work well and everything was sold for a few thousand dollars.
Often, the cost of disposal exceeds the proceeds from selling the assets. In the restaurant example, it would have likely cost more to remove and try and sell the equipment and fixtures than what the sale of these would realize.
Execute the Liquidation
This is when everything needs to come together.
#1. Develop a liquidation plan. This should detail what will be sold, what will be abandoned, and how the assets will be monetized, both from a process perspective (e.g., sell it yourself, hire an auctioneer) and legal perspective (e.g., simple sale or through some sort of legal process — a complicated question and beyond the scope of this newsletter).
#2. Decide on employees.
Who will be kept and for how long
? For example, if there is substantial accounts receivable, recovery will likely be higher if existing staff first collects what it can. Sometimes, the employees can be hired on a part time basis as contractors (particularly the accounting people).
#3. Develop a “waterfall.”
the priority in which creditors will be paid
. Secured creditors get their collateral first, wages, fiduciary taxes next and so forth. Make sure burial costs are funded. When you get to the creditor class that won’t be paid in full, pay on a pro rata basis. Whether or not to contact creditors before disbursing funds is a function of the legal decision made on how to conduct the liquidation. Revise the cash flow projection showing when assets will be monetized with remaining cash disbursed in the waterfall.
Right from the start,
get financial, legal and tax help from people experienced with insolvency and wind downs. This is not the time or place to wing it.
Don’t leave significant cash in the business. A creditor can grab it and use the cash to sue Officers, Directors and owners.
Move quickly, before creditors litigate.
Above all, be honest. Liquidation is painful — usually financially, often emotionally, especially if the business is one you have built yourself from the ground up. Under these circumstances, the temptation to take shortcuts and even obfuscate can be high. Don’t. Fulfill your obligations as legally required, make a clean break and move on.