We’ve been chatting a lot about where to invest your money and all of the different investment vehicles available to the public. All of these things to help you make more money. But what happens when one of these companies you’ve invested in goes bankrupt? And yes, this affects both bondholders and stockholders of the company. We’re about it reveal it all here.
Why should I be concerned if a company goes bankrupt?
Well if you have money invested in it, then surely this is the last thing you want to see happen. After all, when you invest (unless you’ve taken a short position), you generally want the company to generative massive profits for its shareholders (i.e. you).
Even as one of the company’s bondholders, you surely want them to avoid bankruptcy at all costs. Especially if you’re only partway through the term of the bond(s) you’ve purchased.
What happens to the company’s debt and stockholders?
In the event that a company does go bankrupt, here’s the general process:
All of the company’s assets are liquidated. This includes everything from leftover inventory, equipment, machinery, outstanding accounts receivables and more. All of this is sold for cash ideally.
Once everything has been liquidated, it’s time the company pays its debts. At this point, the focus turns to the company’s liabilities. All accounts payables are settled, loans are paid and bondholders are compensated.
After the company’s debts have been handled, it’s time to focus on the equity section of its balance sheet. And yes, this means its shareholders are paid only once all the company’s debts are settled. As you may notice, this means bondholders receive full payment before shareholders see a dime. There’s one more distinction to note in the process. Preferred shareholders are paid before common shareholders.
Which investments are less exposed to default risk?
While no investment is fully safe from default risk, you can see from the process above that some are favored more than others when it comes time to repayment. Specifically, bonds will receive the first claim on any leftover proceeds. Stockholders must really hope there is money left over for them in these unfortunate situations.
But remember, stocks also carry the greatest potential for a high reward, so it only makes sense they carry the greatest risk too.
The best way to avoid these circumstances is to invest in companies with a solid financial grounding or are poised for exceptional growth. Because in reality, both bondholders and stockholders are in for an unpleasant ride when a company files for bankruptcy.
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