This year, there has been a notable increase in commercial bankruptcies in the U.S., driven by challenges like rising costs, a competitive labor market, subdued demand, economic instability, and geopolitical uncertainties. When assessing the worth of a distressed business, it becomes crucial to consider not only its value as a going concern but also its potential liquidation value. This distinction in valuation approaches is essential, and the following outlines their differences, along with insights into how appraisers determine liquidation value.

The Key Differences

The International Valuation Glossary — Business Valuation defines going-concern value as “a premise of value that assumes the business is an ongoing commercial enterprise with a reasonable expectation of future earning power.” Most business valuations focus on a business’ going-concern value. However, for businesses contemplating bankruptcy, liquidation value is another important benchmark.

The glossary identifies two types of liquidation value:

1. In an orderly liquidation, assets are sold piecemeal over a reasonable time period to maximize proceeds.
2. In a forced liquidation, assets are sold as quickly as possible, possibly via auction.

 
Timing, bankruptcy laws, and judicial mandates help determine the appropriate premise of value. Business valuation professionals are familiar with both going-concern and liquidation premises, making them critical advisors throughout the bankruptcy process.

Estimating Liquidation Value

A business valuation can help owners or management decide whether to file for Chapter 7 (liquidation) or Chapter 11 (reorganization) bankruptcy. Further, it can help stakeholders evaluate the viability of purchase offers, management buyouts, and reorganization plans.

Expert analysis starts with the company’s balance sheet. The book values of liabilities are generally accurate, but assets may require adjustment to estimate recoverability and current market values. Valuators also consider the existence of unrecorded items, such as patents, trademarks, customer lists, IRS claims, warranties, and pending lawsuits.

If a company decides to liquidate, the valuator must factor in liquidation expenses, such as lease obligations, severance pay, and professional fees. Typically, money is set aside in an escrow account for these incidentals before the company distributes liquidation proceeds to creditors and investors.

Of course, liquidation analyses are just the tip of the iceberg. Valuators also can advise distressed businesses on myriad issues, such as devising and implementing reorganization plans, projecting expected cash flows, and estimating going-concern values for reorganization alternatives. They can further negotiate debt restructuring with creditors and coordinate bankruptcy filings, among other things.

Work With Valuation Experts

Whether you’re planning to reorganize or liquidate, bankruptcy is a stressful time for a company’s owners, employees, and shareholders. There’s no universal approach that works for all struggling businesses. Contact us to evaluate the situation and help you determine the optimal strategy.