Liquidation Value: a Worked Example

A bank lends against cash flow and takes security for the day the cash flow stops. On that day the business is worth what its pieces fetch, not what its accounts say. Receivables become harder to collect once customers know the supplier is gone, work in progress has no buyer, and machinery sells for what a stranger will pay to dismantle and move it. Liquidation value is the lender's estimate of that day, and it is the floor under the second way out.

It is also the number creditors measure each other against. When a distressed company proposes a deal, one of the first questions creditors ask is whether it beats a liquidation. A lender that knows the liquidation figure knows what it can refuse.

Each asset class gets its own recovery, set by a valuer for plant and stock and by the lender's own reading for receivables. The moving parts are the same in every market. Time: the orderly premise allows a typical marketing period, the forced premise a shortened one, and the International Valuation Standards ask the valuer to state which was assumed. Place: plant valued where it stands, sold with the site to a buyer who keeps it running, is worth more than plant that must be removed, and on a leased site removal is often the assumption. Costs: agents' and auctioneers' commissions, removal, insurance and rent while the assets are held, and the fees of the receiver or liquidator who runs the sale.

The last step is what ranks ahead. In each of the three markets, certain employee entitlements are paid ahead of the secured lender out of particular assets: in New Zealand, accounts receivable and inventory, a priority some Inland Revenue claims share; in Australia, assets subject to a circulating security interest; in the UK, floating-charge assets, where some tax debts are also preferential. Where such claims exist, the lender's share of the receivables and stock is smaller than what those assets realise.

A commercial signage manufacturer, constructed for this page like every figure in it, owes its bank US$6.3m: a US$4.5m term loan and US$1.8m drawn on its overdraft. The bank holds a general security agreement over the company. The factory is leased. The recovery rates below are this example's, set for this business, and are not offered as market norms. Figures in US$m.

Stock and plant both lose more than half their book value even in the orderly case. A third of the stock is part-made signs for named customers, worth little to anyone else. The receivables lose a quarter even in the orderly case, because customers of a failed manufacturer dispute finish, hold back retentions and set off warranty claims. The plant is valued removed, because the landlord will want the building back.

The bank is covered if the sale has six months and short by US$2.1m if it has six weeks. Nothing in the business separates the two columns; only time does. A credit paper that quoted the book value of US$15m against debt of US$6.3m would have shown more than twice cover on assets that would not have covered the debt in a hurry.

Forced-sale value is what one asset fetches when it has to be sold quickly by someone other than its owner, such as a building sold by a mortgagee or a machine sold by a receiver. Liquidation value prices everything a stopped business owns at once, and its forced version is the sum of many such sales less the cost of running them. Going-concern value is what a buyer would pay for the business still trading, earnings and customers included; when it is well above liquidation value, the lender has a reason to support a sale of the business rather than its pieces.

Lending value is the bank's own figure, the share of a security's value it is prepared to lend against. A lender may set it with liquidation value in mind, but the two answer different questions: what would come back, and how much the bank will advance before it is uncomfortable.

DEFINED IN ONE PARAGRAPH → · THE RECOVERY WATERFALL → · WHAT YOUR BANK HOLDS AS SECURITY →

At approval, it sizes the risk the bank is taking if the business fails, and it is where a credit officer tests whether the security case holds at forced values rather than book. In a workout, it frames the choice between enforcing now and supporting the business while it trades: support is worth giving when the business alive is worth more to the bank than its parts, and the gap between the columns tells the lender how much a rushed sale would cost.

In a restructuring, it becomes the benchmark. In the UK, a court can sanction a restructuring plan over a dissenting class only if that class would be no worse off than in the relevant alternative, and the alternative is often an administration or liquidation. In Australia, an administrator must give creditors an opinion on whether a deed of company arrangement, ending the administration or winding up is in their interests, and reports commonly set out the estimated return in a liquidation beside the deed's. A proposal that pays less than the lender's liquidation figure starts from behind.

WHEN A LOAN GOES BAD → · CREDITOR COMPROMISE → · SCHEME OF ARRANGEMENT →