The tough job
of planning your
liquidation
BY ANDREW B. CRITTENDEN,
VICTORIA L. CRITTENDEN AND
WILLIAM F. CRITTENDEN
EXECUTIVE SUMMARY
Whether due to voluntary situations (owner retirement) or involuntary situations
(financially distressed companies), liquidation is often an unpleasant and
painful option for business owners. Regardless of the reasons, it is critical
that the liquidating business understand how best to come to a net orderly
liquidation value and, in the case of a self-liquidation, that the business craft
a phased liquidation process that will create the optimal environment for
maximum gain. We offer insight into determining liquidation value and some
suggestions for a markdown program for business dissolution.
november/december 2016 15
Business strategists spend considerable
time discerning what business to be
in and how to compete in the chosen
business area. Within this process, much
time is allocated to reflecting on the
gestation and growth of a business.
However, little time is spent thinking
about the demise of a business. This is
not surprising given that firms facing
difficult market conditions or those in
financial distress do not necessarily close
up shop. Instead, the first inclination
in such situations is to attempt to turn
around the business; that is, taking steps
toward making the company profitable,
perhaps through identifying new
products or new markets or by focusing
on cutting costs. Yet a turnaround is not
always possible.
Financially distressed companies,
those that have questionable value due
to low or negative operating profitability and marginal opportunity for
turnaround, occur in all industries and
among companies of all sizes. If not
acquired by another corporation, the
options for these distressed firms are
bankruptcy and/or liquidation.
According to BankruptcyData.com,
U.S. public company bankruptcies have
seen a decline since their peak of 211
in 2009 during the heart of the Great
Recession. In 2014, U.S. public company
bankruptcies reached a low of 54. The
U.S. Federal Reserve received partial
credit for the drop in bankruptcies, as its
quantitative easing program had given
many companies access to cheap capital
to sustain their businesses.
However, 2015 saw an uptick in
bankruptcy filings driven by the low price
of crude oil, with the oil and gas sector
contributing 40 of the 79 filings in 2015.
Forty-seven percent of the 2015 filings
were Chapter 7 liquidation bankruptcies.
Additionally, companies with fewer
than 500 employees represented
approximately 90 percent of the 2015
filings. Further, corporations with less
than $10 million in sales volume represented approximately 85 percent of the
2015 filings.
According to the American
Bankruptcy Institute, this recent upward
16 Industrial Management
trend in bankruptcy and liquidation
filings, particularly among smaller
and private or closely held businesses,
continued into 2016. Clearly, in tough
economic times, some companies have
shown they are able to keep themselves
afloat with low interest payments – until
another external shock comes along and
wipes them out.
The typical goal when a company files
for bankruptcy is to restructure company
assets and come out leaner and more
efficient. Retailers, in particular, have
not been fortunate in recent memory in
succeeding with this outcome.
This seems due to structural change
attributable to the wheel of retailing, the
continued onslaught from online and
Darwinian adaptability (or lack thereof).
AlixPartners advisory firm reports that
55 percent of U.S. retailers that filed for
bankruptcy over the past 10 years have
liquidated, compared to less than 5
percent of nonretail filings.
Generally, bankruptcy laws are in
favor of a company’s continuation with
some sort of reorganization plan under
Chapter 11 of the U.S. Bankruptcy Code.
Failing in that regard, the bankruptcy
proceedings likely will be converted
to Chapter 7, or court-appointed,
liquidation. The larger the distressed
company, the more likely it is to garner
attention from the media when it comes
to closing the business and the more
likely the corporation is to engage the
services of an external company specializing in liquidations.
For example, Sports Authority, once
the nation’s largest sporting goods
retailer, originally filed for Chapter 11
bankruptcy with the intent to reorganize
and emerge as a pared-down company.
Struggling, underperforming stores
would be closed, but the overall brand
would continue operating – leaner and
profitable. Unfortunately, the battle to
remain a solvent company was too great
and Sports Authority moved to Chapter
7 liquidation.
Similarly, liquidation followed
Chapter 11 bankruptcy for Joyce Leslie.
With liabilities exceeding assets for this
women’s apparel retailer, the company
filed for Chapter 11 bankruptcy. When
a strategic partner or buyer for the
company could not be found, liquidation
proceedings transpired. Both liquidations were handled by Gordon Brothers,
one of the largest third-party companies
specializing in liquidations.
Liquidation
Little time is
spent thinking
about the
demise of a
business.
Third-party liquidators may add value in
the sale of a company’s assets in various
ways. They may bring a level of expertise
on how to run a liquidation through
particular sales channels, as they bring
an understanding of the customers who
may or may not participate in a liquidation.
They also can remove some of the
emotional issues an owner may face in
self-liquidation. For example, owners,
particularly in closely associated firms,
may struggle with the act of quickly
cutting costs by reducing headcount of
noncritical personnel.
The liquidator marketplace has
become very competitive, with several
liquidators competing to run the same
going-out-of-business sales. This is
driving the value of the underlying
collateral upward, which is a positive
sign for debt-holders. Trade credit
and inventory-based loans are often
important funding sources. Lenders have
now become quicker to push for exit
through liquidation in perceptibly losing
positions as that enables them to retain
as much value as possible.
In general, liquidation is an
unpleasant and painful option for
owners as it involves the termination
of an organization’s existence, and its
impact is felt among a variety of constituencies, including employees, suppliers
and even neighboring businesses. Unlike
a court-appointed liquidation, however,
voluntary liquidation can occur when
the company’s value exceeds its liabilities
yet long-term survival is not foreseeable
and the decision is made to exit the
business. Voluntary liquidation could
occur because the owner is retiring, selfliquidating or creating private equity for a
leveraged buyout.
Liquidation can come in various forms.
WHOLESALE LIQUIDATION MODEL
Figure 1. This detailed synopsis shows what a company might need to consider when determining its
liquidation value.
1) Developing the model – Inputs
a. Inventory by category – Allows company to summarize the inventory details to see what types of inventory make up a greater proportion of inventory
i. Segregate finished goods, work in process and raw materials
b. Sales/COGS /margin by category – Shows higher/lower performing categories
c. SKU analysis – Compares the inventory by SKU to the sales by SKU to determine how quickly the inventory on hand would be sold through
d.Customers – Shows customer concentration
e.Expenses – Rent/salaries/miscellaneous/liquidation costs
f. Optional components
i. Vendors
ii. Age of inventory
iii. Sizes/colors breakdown
iv. Open orders – Is any of the inventory already tied to a purchase order?
2) Calculations
a. Categorical
i. Based on average inventory by category, and COGS calculate inventory turnover
ii. Weeks of supply
iii. Gross margin – What is the normal discount to current customers?
iv. Mark up inventory at cost based on gross margin to get inventory at selling price
(maintained markup)
3) Setting values
a. Phasing – How much inventory can be pushed to the current customers?
i. Capacity calculator – How much inventory is on hand compared to their normal sell-through rate?
ii. SKU analysis – Comparing the inventory on hand to the sales, how much would they sell
during the sale term?
iii.Discount to current customers? What is the difference between gross and net sales?
How much are discounts to customers?
iv. Opportunistic buyers – Who are they? How much of a discount do they require?
b. How long of a sale?
i. How much inventory on hand?
ii. Is the inventory company specific?
iii.Who are the customers? Do they take partial orders?
iv. Additional time to lot up and sell on the opportunistic basis
c. Gross orderly liquidation value (GOLV)
i. Based on the breakdown of inventory, how much of a discount is needed in order to move the different categories of inventory
ii. Percent of sell price recovery and percent of cost recovery
iii. Details flow to phasing – Tie out setting GOLV with the GOLV on the phasing
d. Net orderly liquidation value (NOLV)
i. Starts with total cost of inventory on hand
ii. How much does it need to be discounted to get a realistic dollar recovery (GOLV)
iii.How much does it cost to move that inventory (liquidation expenses)
e. Advance rate (lending rate)
i. Used by banks when setting up asset-based loans
ii. Generally 85 percent of the NOLV (80 percent - 90 percent range)
november/december 2016 17
For example, large companies such
as Sports Authority, Borders and
Circuit City likely will utilize one of
the larger liquidator houses (e.g.,
Gordon Brothers, Great American,
Hudson Capital) or maybe even an
industry-focused large liquidator (e.g.,
Planned Furniture Promotions for a
furniture store going out of business),
while a smaller company might
liquidate by selling off in order to clear
the shelves.
A key step before harvesting a venture
is attempting to estimate the value of
the business. Once that is done, there
is a good chance the company can selfliquidate and walk away with more funds
than if a court-appointed liquidation or
18 Industrial Management
the services of a liquidation firm were
involved.
Valuation techniques: Book, fair
market and liquidation value
The value of a company provides
insight as to whether a distressed
company should liquidate or attempt a
turnaround.
At a basic level, if the value of the
corporation is greater than the debt, then
a turnaround via some sort of restructuring is possible. However, if the value
of the organization is less than the debt,
chances are high for liquidation.
There are several different types of
valuation techniques, and a company
should be aware of the full range of
A key
step before
harvesting
a venture is
attempting to
estimate the
value of the
business.
values, including book value, fair market
value and liquidation value.
Book value is the cost of assets minus
any accumulated depreciation. Net book
value would then be total assets minus
total liabilities. The accounting practices
of the organization can affect the
valuation, yet net book value is a useful
point of departure in understanding a
company’s worth.
Fair market value is the price of
assets sold during the normal course of
business and the adjusted market value
of tangible assets held by the company
as part of its operations, such as land,
buildings and equipment. Fair market
value takes into account balance sheet
discrepancies, such as when long-term
assets have significantly appreciated in
value.
If a financially distressed business is
looking for a partner for reorganization
(e.g., Chapter 11 bankruptcy), the book
value and fair market valuation of the
company will provide a potential buyer
with a plausible range of the market
worth of the corporation.
However, in Chapter 7 bankruptcy or
self-liquidation, the liquidation value
of the company is the critical valuation
technique. The liquidation value of a
company is the worst-case scenario for
analysis. Essentially, the valuation determines the net cash amount that could be
realized if all of the assets were disposed
of and liabilities settled.
Liquidation value model:
Know before you dissolve
By selling off assets and paying off
liabilities, the liquidation value model
assumes the business will cease operations. It is imperative that the liquidating
business understand how best to
come to a net orderly liquidation value;
otherwise, it puts itself at risk for relying
on a third-party vendor’s calculations.
However, the liquidation value model
has to take into consideration that the
assets will not bring as much during a
liquidation sale as they would if they
were being sold under normal market
conditions.
In other words, liquidation is often
equated to “desperate,” but a desperate
seller can also be a smart seller.
The items a company needs to
produce an inventory liquidation model
are especially common for retailers and
wholesalers. Firms should have such
information, things like inventory, sales
and financial history, readily available. If
the information is not easily accessible,
there are likely internal control reasons
that are behind the need to liquidate. The
basic inputs for an inventory liquidation
model include:
• Financial history for 24 months
(income statement and balance sheet)
• General and administrative (G&A)
expenses
• Customers
• Vendors
Having this information enables
the business to begin to determine the
“fire sale” value of the enterprise. Age
of inventory, product seasonality, colors
and sizes can adversely affect valuations.
For example, technology inventory ages
poorly, as it can become obsolete very
quickly.
Relatedly, customer buying power
will influence the level of discount
necessary to move product quickly. Figure
1 provides a more detailed synopsis of
considerations a company might go
through in determining its own liquidation value.
Once the decision has been made
to liquidate, the business must begin
the liquidation process from a knowledgeable vantage point. Too often, the
distress associated with the decision
to liquidate overrides the necessity of a
well-thought-out, structured plan with an
expected timeline.
To self-liquidate or not?
• Inventory by stock keeping unit
(SKU) per category
• Sales and margin by SKU per category
for a 12-month period
Once the value of the company is understood, the entity is at a critical decision
point in its plans to liquidate. That is,
should it file Chapter 7 bankruptcy? Hire
Too often,
the distress
associated with
the decision
to liquidate
overrides the
necessity of a
well-thoughtout, structured
plan.
a third-party liquidator? Self-liquidate?
The first two options, Chapter 7
bankruptcy and third-party liquidator,
incur additional costs to the company.
There are court costs and appraisal costs
by a qualified appraiser. Additionally, the
company may ultimately receive less than
the self-liquidation value of the corporation’s assets since a third-party liquidator
is in the business to make money. Yet,
by having calculated its own liquidation
value previously, the dissolving business
is in a better position to negotiate the
execution of the sale as it moves to
discussions with professional liquidating
companies. The decision made at this
junction sets the stage for the closing of
the business.
The calculation of the liquidation
value, including allowances for the
various costs associated with holding a
liquidation sale, represents the ceiling for
a liquidator’s investment in the business.
Third-party liquidators may work for a
weekly fixed rate or for a percentage of
gross revenue, or the third-party liquidator may buy the company’s assets and
assume the entire risk and reward of
selling. For the seller of the business, the
liquidation value is the floor below which
the seller is unwilling to sell because it
would be better to liquidate the business
without the use of a liquidator.
If the company decides to use the
services of a third-party liquidator
(a company does not have to be in
november/december 2016 19
bankruptcy to hire a professional liquidator), a qualified appraiser will need
to determine the liquidation value of
the business. This qualified appraisal
value might identify areas that the seller
had not considered previously, and a
qualified appraiser also may have a more
accurate indication of the marketplace
for liquidations at a particular point in
time since the marketplace is not fully
efficient.
Should the decision be made to
self-liquidate, however, the company
likely will move directly to a phased
liquidation process in which supply
delivery is ceased and products are placed
on various types of price markdowns.
Knowing the value of the asset will
enable the purveyor to develop an appropriate markdown process.
However, it is important that the
determination of a markdown program
take into consideration the mentality
of the marketplace. That is, markdowns
should not be too steep initially, nor
should all assets be placed on markdown
immediately.
Thus, prior to the actual liquidation
process, an enterprise should determine
a markdown strategy for its inventory.
Included in this step of self-liquidation
is planning the promotion for the
liquidation. Key suggestions with selfliquidations include:
• Determine appropriate price
markdowns, as this helps draw traffic
that is especially needed on hard-tomove and out-of-season product.
• Keep store shelves neat so customers
can find deals without getting
frustrated.
• Use large, correct signage.
• Get inventory out of backrooms/
storage/warehouses, especially those
hard-to-move and seasonal items.
• Use the company website, as well as
eBay, Amazon, Bonanza and Newegg,
to sell inventory.
• Use the customer database to mail
and email promotional material.
• Consider auctions, especially for hardto-move and seasonal items.
• Contact competitors about unloading
20 Industrial Management
LIQUIDATION
CUSTOMER
CHANNELS
some inventory at distress prices.
• If you have multiple stores, combine
inventory where it is most likely to
move and closeLiquidationcustomerchannels
stores where operating
Figure
Companies undergoing liquidation can sell inventory thro
costs can be cut and/or
a lease2.ended.
channels.
As depicted in Figure 2, inventory can
be sold through a variety of channels.
Current customers will offer the highest
recovery value as they will take the
inventory with a slight discount, often to
account for final sale terms. However, the
sales window tends to be the longest of
the identified channels.
Online auctions may be run at timely
intervals with an anchoring and buy
immediately pricing. Some online auction
buyers are hoping to take advantage of
significant discounts and may be looking
to resell the assets for a profit. Opportunistic buyers (e.g., off-price retailers)
expect significant discounts, tend to buy
in large quantities and will look to resell
the assets for a profit.
Jobbers tend to be the final channel
used, as they want very large discounts.
Often these buyers are taking extra
inventory at the lowest cost with the
idea of holding onto the items to sell at a
much later date.
The dissolving business concern must
understand that a liquidation often takes
on a life of its own. If it is a retail store
liquidation, state laws may govern the
length of liquidation sales. For example,
a going-out-of-business sale is likely
restricted to 60 to 90 days depending
on state laws. That is, stores cannot hold
perpetual going-out-of-business sales.
But there is nothing to prohibit
the retail business from gradually
reducing its inventory and clearing its
merchandise before the final going-outof-business sale takes place.
In other instances, the liquidation
may be governed by lease arrangements.
A lease may stipulate a 90-day prior
notice of nonrenewal. Therefore, the
business will have to time its liquidation
consistent with lease requirements or
face penalty fees to a landlord. Thus, it is
imperative that the business has a clear
understanding of the timing requirements for the dissolution of the business.
Figure 2. Companies undergoing liquidation can sell
inventory through a variety of channels.
Current
customers
Liquidating
company
Online
auctions
Opportunistic
buyers
Jobbers
Dealing with a rough decision
Prior to
the actual
liquidation
process, an
enterprise
should
determine a
markdown
strategy for its
inventory.
Many enterprises linger at the abyss of
financial distress. Cash flow concerns
can evolve from trade credit restrictions, account receivable delinquencies,
increasing costs, shifting consumer
sentiment and debt limits.
Sometimes businesses are able to
move from the chasm on their own
accord by adroit asset redeployment or
partial liquidation (e.g., closing some
operations, a fire sale of some inventory).
In some instances, companies find it
necessary to file Chapter 11 and obtain
court protection and oversight to return
to solvency.
In other cases, corporations are unable
to regain solvency and will be dissolved.
The goal of liquidation is to dissolve all
the company’s assets, pay off all creditors
and split the remaining proceeds among
the owners of the firm. Understanding
the liquidation value of the corporation
enables management to make decisions
that will optimize any payout to the
owners.
For many executives of closely
associated firms, liquidation can be
an emotionally traumatic experience.
In these instances, managers need to
determine if they are able to shepherd the
organization objectively through liquidation or if the process is best left to an
experienced third party. v