When a company goes bankrupt, it often makes a big splash in the news. Companies like Lehman Brothers, General Motors, Enron, Chrysler, and others have declared bankruptcy at some point. While companies like Lehman Brothers and Enron faded away, others like General Motors continue on.
Company bankruptcies are often complex and lengthy processes. In the period leading up to, during, and following a bankruptcy, the financial issues are almost certain to affect shareholders. Learn more about what happens to stock if a company goes bankrupt.
Bankruptcy: Definition and Facts
When a company has so much debt that it can’t realistically keep up with its bills, it has several options moving forward. One of those options is bankruptcy.
According to the United States Courts, bankruptcy is “a legal procedure for dealing with debt problems of individuals and businesses; specifically, a case filed under one of the chapters of title 11 of the United States Code (the Bankruptcy Code).”
Looking past the legal jargon, bankruptcy is a process of dealing with extreme financial problems in bankruptcy court. This is rarely good for the company, its shareholders, or its debtholders.
What Bankruptcy Means for a Company
For the company, the results of a bankruptcy depend on the type of bankruptcy filing. As a general rule, however, when a company can’t keep up with its debt payments, there is a certain priority of who gets paid.
First, secured creditors get paid for any outstanding debts. Banks and other lenders who may hold mortgage loans, equipment loans, or other secured debt agreements with the company are considered secured creditors. Next, unsecured creditors, including banks, suppliers, and bondholders, get paid. Shareholders are last in line for payment.
Chapter 11 Bankruptcy
For bankruptcies of public companies, Chapter 11 can be thought of as the “good” kind of bankruptcy. The goal here is a reorganization. This generally includes restructuring debt, reducing expenses, and a focus on turning around cash flow.
Ideally, the company continues operating after Chapter 11 is filed. Retailer Sears is a well-known example of a public-company bankruptcy. It has far fewer stores since it filed for bankruptcy in 2018, but it’s still in business. While Sears continued to trade in the market before and after its bankruptcy, its share price has significantly decreased over the years, trading around $0.20 per share at the end of June 2020.
The SEC warns investors against buying shares of a company in Chapter 11 bankruptcy, calling it “extremely risky” and “likely to lead to financial loss.”
Chapter 7 Bankruptcy
Chapter 7 is the “bad” kind of bankruptcy. With a Chapter 7 filing, the company is going out of business and will liquidate its assets.
In this situation, a trustee sells off all company assets and pays off debts as explained above. If anything is leftover, the shareholders get to split the pot. But in many cases, shareholders won’t receive anything after the company goes through Chapter 7 bankruptcy.
One example of a high-profile Chapter 7 bankruptcy is Helios and Matheson, the parent company of the infamous MoviePass. It filed Chapter 7 bankruptcy in January 2020.
What Bankruptcy Means for Shareholders
Shareholders are the last ones to be paid out if a company goes out of business. In many cases, those owning stock won’t get anything back at all.
If a company goes through a reorganization in bankruptcy, the stock is likely to go way down in value. It could get so bad that the stock is delisted from major stock exchanges.
The stock could very well become completely worthless. But there’s always a chance that the company could emerge from bankruptcy stronger and stock prices may rise. In the short-term, however, the stock price is likely to stay very low during bankruptcy and immediately after.
What Can a Company Do Next?
If a company files for bankruptcy, it should work hard to pay off and reduce its debt load and operating expenses to stay in business. Unfortunately for many workers, that process often involves layoffs.
If management does a good job of navigating the financial challenges, the company can emerge from Chapter 11 bankruptcy with an opportunity to become profitable again. Companies that file for Chapter 7 bankruptcy close their doors for good.
What Can a Shareholder Do Next?
Shareholders typically don’t have good options when a company declares bankruptcy. By the time the bankruptcy filing hits the headlines, the stock price has likely plummeted, reflecting the company’s current financial reality.
Shareholders may be able to sell their shares of stock if it’s still listed on an exchange or they can sell it over the counter (OTC) and may have to take a loss. If they can’t sell, they’ll have to wait out the bankruptcy and hopefully get some financial relief in the future.
However, a likely outcome is that the company will cancel all the existing stock, rendering your shares worthless.
If, as a shareholder, you have faith in the management and business model, it’s possible that the company will recover and the stock price will follow suit. That may be a risky bet, however, because there’s a high probability the company will cancel your shares.
Should the company make it out of bankruptcy, then there’s a chance it’ll offer its pre-bankruptcy stock in the over-the-counter market and then offer new stock that’s publicly traded on the stock market.
If you want to buy back into the company after bankruptcy, know that the company’s OTC stock will have a “Q” at the end of the ticker name. This old stock is more volatile and could be worth very little. The new stock the company sells may have a “V” at the end of the ticker name or won’t have any additional letters.
The Bottom Line
Bankruptcy can mean the end of the road for a struggling company or a fresh start with fewer debt burdens holding it down. In either case, bankruptcy is not good for a company’s stockholders. The share price will likely go down—possibly to zero—in the wake of a bankruptcy filing.
Some stock owners may sell their shares and abandon ship at the first sign of financial trouble. Others may be happy to hold on to their shares and ride out the storm, but they do so at the risk of total loss—the company could cancel your shares during bankruptcy proceedings.