Bankruptcy and Stockholders

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When a company goes bankrupt, what happens to its stockholders? Nothing good—they can have most or all of their investment wiped out overnight. In fact, it’s for shareholders to have their investment wiped out; it’s more the exception when it doesn’t happen.

Stockholder vs Bondholder

There are two main classes of investors in corporations: stockholders and bondholders. Stockholders own equity—they own a piece of the company. A company’s stockholders are its owners. Like a sole proprietor, stockholders have unlimited upside: any profit the company throws off, or any growth in its share price, belongs to them. However, at the same time, they can lose it all: like the owner of a small business, if a company goes out of business or bankrupt, they can lose their entire investment.

A bondholder is a lender. A corporate bond is a promissory note. Bondholders have their upside limited by the terms of the bond—they only earn so much interest, for example. However, while they, too, can lose their whole investment if the company cannot pay their bonds, bondholders are creditors, not owners. If the company goes bankrupt, they have a better chance to receive at least part of their investment back.

Priorities in Bankruptcy

In a bankruptcy, creditors and investors are paid in a definite order, or priority. In best shape are secured creditors, such as banks who loaned money to buy real estate, or suppliers who maintain a lien on inventory until they are paid. Secured creditors can look to the collateral behind the debt to make sure they’re paid.

Next best off are unsecured creditors, or people, institutions, and businesses who loaned the corporation money, or provided goods or services, without receiving any collateral for it. While there are priorities among creditors, all creditors (including bondholders) are paid before owners receive anything.

Common vs Preffered Stock

There are two types of stock available in a company. The more common type, called common stock, is what is usually thought of as “stock.” It’s a percentage ownership in the company, and the common stockholders are the ones who truly own the corporation.

There’s also a kind of instrument called preferred stock. Preferred stock is sort of a hybrid between stocks and bonds. Without getting into the complex details of preferred stock, the important point is this: preferred stock has priority over common stock in a bankruptcy.

Why Common Stockholders are Usually Wiped Out

Remember, a company goes into bankruptcy because it does not have enough money to pay its obligations. From whatever the company does have, secured creditors, unsecured creditors, and preferred stockholders are all paid before common stockholders. The well has typically run dry by the time common stockholders finally get to the head of the line.

How a Bankruptcy Lawyer Can Help

If you own enough common stock of a company that it is a significant investment to you or you are a significant investor in it, if it looks like the company is going bankrupt, have an attorney review any proposed reorganization plans or distributions. An attorney can help you determine is the plan includes any double dealing, self dealing, or fraud that may give you the right to object, increasing your odds of recovering some part of your investment.

 

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