3 ms·
> . When private companies screw up, who gets left with the bill? In theory, the company is meant to declare bankruptcy (or seek more investment from sharehold
by phire 6y ago
> . When private companies screw up, who gets left with the bill?
In theory, the company is meant to declare bankruptcy (or seek more investment from shareholders) as soon as their books say they are insolvent. A company is Insolvent when it's liabilities are higher than it's assets, even by a single dollar.
The theory is that because the company is required to declare bankruptcy as soon as possible, it should only be slightly insolvent and should be able to repay creditors 80-95 cents on the dollar after liquidation.
Owners or shareholders might even put a company into bankruptcy while it's still solvent (if they predict a future insolvency, or just want to wrap the company up). Creditors might get the full 100 cents on the dollar. Any money beyond that is paid as dividends to the owners/shareholders.
In theory, if a company had incompetent or fraudulent accounting practices and didn't know it was insolvent, or it deliberately traded while insolvent, then the liability of the company is pierced and the owner can find themselves on the hook to the creditors.
Companies are only meant to be liability shields if they are run correctly.
In reality, sometimes events cause a company to lose a whole lot of value overnight. A company could be 100% solvent one month and 20% solvent the next. But as long as the company was following best accounting practices, it's legal. Sometimes the assets of a company can lose value after bankruptcy, or due to the bankruptcy. Especially when the company has put a lot of "good will" or "brand recognition" as assets on their books.
In reality, liquidators (who are also private companies) often don't go after owners responsible for fraudulent accounting or mismanagement. They let it slide.
Perhaps because they didn't detect it, or it was too minor to worry about. Perhaps they didn't want to waste their time trying to prosecute. Perhaps they decided their creditors would get more cents on the dollar by not prosecuting, especially if the owner has very little of their own assets.
I also suspect there is a reputation factor. Owners get to select which liquidator handles their bankruptcy (unless it was court ordered) and if one liquidator gets a reputation for going after the owners for every mistake, then they might get less business.
- jonsen 6y agoThank You! Very informative.
- enkid 6y agoI've never heard this interpretation of bankruptcy. What I have heard is it's used when an entity can't repay their debts. This is not equivalent to liabilities being one dollar larger than their assets. Normally, bankruptcy doesn't dissolve the entity, it just restructures the debt. Dissolving the company can be done without bankruptcy and I believe is the process you are talking about when a company is fully solvent, but is wrapped up.
- phire 6y agoIn the US, there Chapter 11 Bankruptcy (which is restructuring, as you say) and Chapter 7 Bankruptcy which is the liquidation due to insolvency that I describe here. Where I live, there is no formal equivalent to Chapter 11, and liquidation is colloquially known as Bankruptcy. While the terms may vary, the accounting and the general laws are reasonably constant world-wide.
- enkid 6y agoChapter 11 is a form of bankruptcy that leads to dissolution, but it is not the only way to dissolve an entity. In other words, dissolution can be caused by bankruptcy among many other ways. One of these is paying off all creditors and shareholders. Since this does not require debt restructuring, it would not require bankruptcy.
- clcaev 6y agoIn this case, we're talking about a rural electric cooperative; it has no equity owners. They are controlled democratically by member-owners.
- sergiosgc 6y agoThe question here is risk management, in monopolistic markets. The company can be run in high risk mode, under the assumption that if the risk realizes it will just go bankrupt and be bailed out. It wouldn't be bailed out in a competitive market, because competitors would pickup the slack, they would capture the market that was left without a service. In a monopolistic market, a normal bankruptcy would leave the market without a service provider, and thus a bailout is needed.
- SomeHacker44 6y agoI do not think this reflects reality. Companies declare bankrupcies when their negative cash flow exceeds their cash reserves and they cannot put off creditors any further. Until then, they are a going concern. Alternatively, they declare bankrupcy when it will best help their owners. Assets and liabilities do not play much into the calculus. Just my observation from decades of startups and small companies and reading the news.
- phire 6y ago"cash reserves" are on the assets side of the balance. Often in smaller companies and startups they may be the only real asset, so when it runs out, the company is insolvent. The other aspect to liquidation is cashflow. Sometimes companies have plenty of assets on the book to cover their liabilities, but these can't feasibly be sold in a timely manner to pay the creditors who want their money now. If the company is healthy, a bank will be willing to offer a bridging loan. But if the company is less-than-healthy, the only option might be liquidation. I didn't cover this about, because in these cases, the creditors are almost guaranteed to eventually get 100% of their money back.
- fitchjo 6y agoAs a couple other replies have mentioned, determining insolvency and when to file bankruptcy is a bit more complicated than this simple comparison. A quick counterpoint - you start a company on Day 1 and put $1 into the company; on Day 2, you borrow $10, but with the costs associated with borrowing, you only net $8 cash; at that point, you have outstanding debt (liabilities) of $10, but cash (assets) of $9; your new company is not insolvent, however - you can take that $9 and generate additional cash flows that allow you to repay the $10 debt in the future. While certainly not common, there are plenty of companies operating that have negative equity - it certainly is an indicator of a company having some challenges, but not an absolute that the company should be dissolved.