Is it Better to Sell Stock Before the Company Goes Bankrupt?

It's never fun when you own stock in a company that's tumbling toward bankruptcy. Day by day, you watch the value of your investment shrivel along with the stock price. If there's any consolation, it's that the stock can't fall any lower than zero. And it probably will hit zero. The Securities and Exchange Commission warns that stock in bankrupt companies usually winds up worthless, so if you can sell before the company finally hits bottom, you might want to do so.

Types of Corporate Bankruptcy

The U.S. Bankruptcy Code gives a failing company two options: Chapter 7 or Chapter 11. When a company files for bankruptcy under Chapter 7, it means the party is officially over. The company will sell of all its assets, pay whatever debts it can, shut off the lights and cease to exist. In a Chapter 11 bankruptcy case, the company keeps operating, but it reorganizes its operations.

At the End of the Line

When a business of any size goes bust, the bankruptcy court isn't there to make sure the business owner gets taken care of. It's there making sure that creditors -- those who are owed money by the business -- get taken care of. Whether it's a liquidation bankruptcy or a reorganization, the primary concern is paying off as much of the debt as possible, then erasing those debts that can't be repaid. Everyone with a stake in the company essentially gets in line, and the court arranges for them to be repaid according to how much risk they assumed. The last people who will see any money from the business are the owners of the business -- the ones who assumed the greatest risk. Stockholders, of course, are the owners of the business. They get paid only if there's money left over after taking care of the debts. But guess what: If there had been enough money to take care of all the creditors, the company wouldn't have needed to go into bankruptcy.

Selling While You Can

If you had a crystal ball and knew that a company was headed for Chapter 7 bankruptcy, your best bet would be to sell while you still could. Your stock will become worthless, and there's next to no chance that you'll get any money from the company's assets. If the company is bound for Chapter 11, there's a glimmer of hope, but it's faint. The SEC says reorganization plans usually involve canceling the stock. In some cases, though, the reorganized company may issue all-new stock, and you might get a chance to swap your old shares for new ones. Alas, you can't predict the future with 100 percent confidence, so your decision on whether to sell will depend on your assessment of where the company is headed.

Finding a Buyer

Of course, selling stock in a company that's swirling down the drain may be easier said than done. Ask yourself whether you'd want to buy stock in a company you know is going bankrupt. Deciding whether you should sell is nothing more than an intellectual exercise unless you can actually find a buyer, and the reason stock prices sink is that there are more people seeking to sell than to buy. You still might find someone willing to take a chance that the stock will retain some value or will be converted to shares in a reorganized company. Even if you get a nickel a share, that's still more than nothing. Or, if the investment has already lost nearly all its value, you might decide to take that chance yourself.

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