What Happens to Shareholders in a Bankruptcy?
Investment is the business world's big gamble. Small investments in risky companies may pay off handsomely, while large investments in stable firms often provide long-term income. Any publicly-traded company, no matter how stable, may go bankrupt. In most cases, shareholders find their stock worthless after a bankruptcy. Sometimes, however, shareholders may receive a portion of their stock value during the bankruptcy, or may find other recourse to collect some of the value of lost stock.
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Order of Debtors
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When a publicly-traded company enters bankruptcy, shareholders are placed in the category of either preferred shareholders or common shareholders. Debts are paid off in the following order: government, secured creditors like financial institutions, unsecured creditors like the electric company or a janitorial service, bondholders, preferred shareholders and common shareholders. It is not uncommon for all shareholders, and especially common shareholders, to get nothing at all after bankruptcy.
Time Frame
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If there is money left over to pay shareholders, it will not be there right away. Publicly-traded companies tend to be large and complex, and it takes time to liquidate all assets. In addition, money is paid to creditors in the order listed above, from government to common shareholders. Often, those shareholders lucky enough to get some payout will see nothing for over a decade.
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Amount Paid to Shareholders
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After the full liquidation of a company and the payment of higher-tiered creditors, the remaining cash is divided between the shareholders proportionate to how much stock they held in the company. Preferred shareholders are paid first, up to the full value of the stock they held, and common shareholders get whatever is left divided proportionately.
In a Chapter 11 bankruptcy where the corporation continues operating, sometimes cash is not paid out, but rather stock is issued to debtors proportionate to the cash they would have received in a liquidation. If the post-bankruptcy value of a company is less than the amount owed to non-shareholders, this results in the value of all current shares being wiped out. Even when there is some equity left over for shareholders, the value of their stocks is severely diluted.
Other Recourse
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In some rare cases, a judge may rule that shareholders may go after the assets of corporation management in the case of corporate bankruptcy. This is always after serious wrongdoing is found, and may or may not result in shareholders recouping some of their investment.
Other Possibilities
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Not all bankruptcies are the same. Often, corporations may go through a pre-packaged bankruptcy, which is much more like reorganization. Pre-packaged bankruptcies are carried out under SEC rules with the assent of two-thirds of shareholders, and while stock value nearly always declines, it is usually better than the often complete loss of a regular bankruptcy.
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