Voluntary liquidation is when a company decides to dissolve itself on its own terms, as approved by the shareholders of the company. The decision usually occurs when a company decides that it has no reason for operating anymore, or if it is not feasible to operate anymore. The key factor here is that the dissolution of the company is not ordered by a court.
How Voluntary Liquidation Works
Voluntary liquidation allows a company to terminate its operations, sell off assets, and dismantle its corporate structure while paying back designated creditors based on their seniority.
Voluntary liquidation is initiated by a company’s shareholders or ownership when they vote for a resolution to cease further operations. The liquidation can proceed only with the shareholders’ approval.
Voluntary liquidations are significantly different from involuntary liquidations. Involuntary liquidations are when a company is forced to liquidate and sell its assets by economic conditions, company regulations, or court order.
A common form of involuntary liquidation for public corporations is when a company goes bankrupt. However, for smaller family-run companies, a death or divorce may result in such a liquidation.
Reasons for Voluntarily Liquidation
1. Unfeasible operations or poor operating conditions
Although they are not forced, voluntary liquidations may sometimes be the best option for companies with unfeasible operations and poor operating conditions. An example is if a high-cost oil producer foresees a period of low oil costs for the future. They may voluntarily decide to liquidate even if they are not technically bankrupt yet.
2. Tax relief
Another reason for electing to voluntarily liquidate operations would be to take advantage of tax reliefs for shutting down, reorganizing, or transferring assets to other companies in exchange for shares of the acquiring company. It is favorable for the target company since the equity portion that is transferred receives favorable tax treatment.
3. Special purpose(s)
Another reason that voluntary liquidation may occur is if a company is only in existence for a specific purpose over a limited amount of time. For example, the creation of a special purpose entity (SPE) or special purpose vehicle (SPV) is a subsidiary company created for the sole purpose of carrying financial obligations to isolate risk. The companies may be voluntary liquidated if they are no longer needed.
4. Departure of company founder (or another key executive)
Lastly, a voluntary liquidation may occur if a key member of an organization leaves the company. For example, the founder of a company decides to leave, and the shareholders decide not to continue operations. It is common for companies that were created from the ground up by a founder, and when they retire, the company is not expected to function the same.
Process of Voluntary Liquidation
Voluntary liquidations may end up commencing when a specific event that is outlined by the board of directors occurs. In such cases, a liquidator is appointed.
A liquidator is an entity that liquidates assets on behalf of a company. When assets are liquidated, they are generally sold on an open market for cash and other equivalents. Liquidators have the legal power to act on behalf of a company for various actions.
When a company is liquidating, whether it is voluntary or involuntary, they will appoint a third-party liquidator to sell their assets for them. Liquidators essentially have the legal authority to act on behalf of the company to sell assets and complete a liquidation. Liquidators are sometimes referred to as trustees as well.
Liquidators must follow the order of obligations, though. For example, the most senior debt levels must receive cash from liquidation first, then subordinated debt, mezzanine financing (preferred equity, payment in kind), and then finally, equity holders receive cash from liquidation last.
Voluntary Liquidation in the United Kingdom
Voluntary liquidation processes may be different in other countries. For example, in the United Kingdom, voluntary liquidations are divided into two different categories. One is for the creditors’ voluntary liquidation, which usually occurs when a company is facing insolvency.
The second category is the members’ voluntary liquidation, which only requires the corporation to declare bankruptcy. With the second category, the company remains solvent. However, it must divest some of its assets to meet upcoming obligations, such as an upcoming debt maturity. At least 75% of shareholders must vote in favor of a members’ voluntary liquidation for it to be enacted.