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Liquidating equity definition real estate


Understanding an investment's place in the "capital stack" is one of the most important aspects of due diligence an investor must complete prior to making any investment. The "capital stack" refers to the legal organization of all of the capital placed into a company or secured by an asset through investment or borrowing.

The capital stack determines who has legal rights to certain assets and income, who receives priority of payment in the event of an uncured default, and in which order each party may be repaid or given authority to take over or liquidate assets in the event of a bankruptcy. Simply put, your place in the capital stack can make all the difference in the world between Liquidating equity definition real estate complete loss and full recovery of your investment when things go wrong.

With just about every investment you make, your place in the capital stack determines the amount of security or downside protection and upside potential you receive. Your place in the capital stack also determines which tax benefits or lack thereof you are eligible to take and how you are able to categorize the income you receive from an investment.

Understanding your place in the capital stack is of equal importance and goes hand in hand with understanding the collateral and value that ultimately back your investments. The following is a detailed breakdown of an idealized capital stack for the company category of collateral which includes stocks, bonds, annuities, etc.

Note that seniority of security and priority of claims increase as one goes from top to bottom. Thus, the lower you are in the capital stack, the more secure your position. In the event of a bankruptcy that results in liquidation, taxes would be paid first, followed by employee wages, senior secured bonds, and so forth down the line until all net liquidated capital is distributed based on priority and seniority within the capital stack.

Generally, by the time the secured bondholders have been paid back assuming that there is sufficient liquidated capital to such pointunsecured bondholders are left with a fraction of what they were originally owed by Liquidating equity definition real estate company, and common equity common stock and preferred equity shareholders are entirely wiped out.

Though it is rare, in some cases of extreme indebtedness or fraud, even the secured bondholders may have trouble recovering all capital owed.

The value of the assets securing the bonds may be the only potential recovery for secured bondholders in these cases. If there are not enough liquid funds to pay secured bondholders, the bondholders can take over the assets securing the bonds and then decide thereafter whether to hold the assets for some other productive use or liquidate them to attempt to recover a portion of the capital owed.

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