Liquidation Value (Valuation) - Explained
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What is Liquidation Value?
Liquidation value is an asset-based method based upon the value that the business would immediately receive upon selling the asset on the open market. Immediately means selling the asset within a six to twelve month period. This method takes into consideration the age, wear, and technological innovations associated with this type of asset.
The liquidation value is notably different from the book value, as assets with no book value may still have a liquidation value. This is common with assets that are expensed or subject to accelerated depreciation. Further, assets of the company may appreciate, the value of which is not accounted for on the companys books. This is common with real estate assets.
The liquidation value method is similar to the adjusted book value method in that it provides a market value for the assets of the business. The difference in these methods is that liquidation value provides an additional context to the valuation.
The liquidation approach assumes that the business has failed and has to immediately sell the asset. One context may be the sale of the assets in an organized process such as bankruptcy liquidation. The adjusted book value approach does not account for the immediacy of sale or the possible effect of the companys failure on the ability to receive a market price.
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Issues with Liquidation Value
The liquidation value method, like other asset-based methods, fails to capture the value of the business as a going concern. Further, it is incapable of attributing relevant value to intangible assets that lack an immediate comparable value in an immediate market. This method, however, does provide useful information to creditors of the business. Also, prospective lenders may use this method to determine the creditworthiness of a business for future capital. Creditors and lenders will often be forced to liquidate debtor assets in the event of default on a secured loan. As such, creditors will need to understand the value of assets based on an immediate sale in the present market. This method is effective when determining a creditors position or priority in the event of the debtors chapter 7 bankruptcy.
Intangibles and the Asset-Based Valuations
In addition to the failure of asset-based approaches to consider the entity value as a going concern, a salient deficiency of the asset-based approaches is the inability to accurately determine the value of intangible assets. This is particularly important is many startup ventures. These assets are difficult to value and often only have value within the business as a going concern. Examples of valuable intangibles include: on-going business relationships, industry reputation, brand recognition, human capital (knowledge or experience), and intellectual property (trade secrets, trademarks, patents, copyrights, etc.). All of these are intangible assets that serve to increase the value of the firm. In other instances a firm may have intangible assets that put the company at risk. For example, the firm may be the subject of intellectual property litigation.