In 2024, bankruptcy filings rose to a 14-year high on account of inflation, rising interest rates, and shifts in consumption behavior. Since these market trends are expected to persist in 2025, unfortunately, we can expect the volume of bankruptcy filings to stay high.

Often, due to unforeseen emergencies or strategic missteps, filing for bankruptcy becomes a necessary step to reorganize finances, repay creditors, and seek a path to recovery. However, poorly executed bankruptcies can diminish a company’s chances of revival and tarnish the reputation of its leadership.

One of the critical components of a successful filing is the preparation of defensible valuation reports which are pivotal in determining outcomes for stakeholders. Hence, in this article, we will go over some of the most common challenges in bankruptcy valuations and explain how you can navigate these challenges effectively. Read on to learn more!

Valuation issues in liquidation bankruptcies

When a business is well past the point of recovery, it can file for Chapter 7 bankruptcy wherein the company is liquidated to repay the creditors. In this type of bankruptcy filing, the valuation exercise would focus on finding the value of the company’s assets.

Some of the issues that can arise in such valuation exercises are as follows:

1. Valuing intangible assets

In a bankruptcy filing, two types of intangible assets may be used to settle debts and they are company brand and intellectual properties. In the rare case when a company maintains a good relationship with its customers right up to its bankruptcy filing, creditors or competitors may show interest in the company brand. 

However, often a company’s reputation is closely tied to its business practices, production processes, and assets like state-of-the-art machinery and plant. In such cases, it might be important to understand how the brand enhances the value of tangible assets which might be offered as collateral to creditors.

On the other hand, intellectual property rights are notoriously difficult to value because of difficulties in estimating the market size and potential for licensing revenue, quantifying the level of protection against imitations, and accounting for the risk of replacement due to technological advancements.

2. Liquidation value assessments

To ensure that the creditors can recover as much as possible, a valuation expert must assess the value of any sellable assets such as buildings, machinery, commercial vehicles, and specialized equipment. This will mitigate the risk of selling the assets at an unwarranted discount. 

However, often, there isn’t a market for many assets. In such cases, extensive research into past transactions is necessary. If a significant amount of time has passed since the last transactions involving similar assets, the valuation expert must take stock of changes in industry conditions, capital goods markets, and macroeconomic conditions to appropriately estimate the value of assets.

Valuation issues in reorganization bankruptcies

In a Chapter 11 bankruptcy filing, a distressed company will continue operating under court supervision as it optimizes its finances, initiates negotiations with creditors, and settles some of its debts by selling its assets. 

Here, in addition to asset value estimations, the valuation exercise will also concentrate on cash flow projections. Some of the issues that can arise in such valuation exercises are as follows:

 1. Liquidation value v/s value in continuing operations

In a Chapter 11 bankruptcy, under a high level of scrutiny, a company must demonstrate that it can generate more value by continuing operations than by liquidating. By the time a company reaches the stage where it must file for reorganization bankruptcy, its creditors will have grown anxious to recover their credit. Then, as part of its reorganization efforts, it must request some creditors to consider longer tenures for repayments.

Thus, a company must present a credible valuation report that validates its ability to generate sustainable cash flows and repay creditors over time. This report must contain detailed cash flow projections and asset valuations.

For the reorganization plan to be accepted, the cash flow projections should be comfortably higher than asset valuations. However, creditors may argue that if such cash flows were feasible given the company’s current asset base, bankruptcy might not have been necessary. Such skepticism must be addressed by company promoters through compelling evidence regarding market potential, transparent financial projections, and operational plans that are robust as well as executable.

2. Estimating the impact of downturns

Often, companies file for Chapter 11 bankruptcy during economy-wide or industry-specific downturns. In such cases, it is important to estimate the impact of the crisis on the company’s ability to generate revenue. Such analysis is easier to execute when the company’s scale of operations has remained the same for an extended period and its financial history spreads across multiple business cycles. 

However, various adjustments and discounts must be cautiously applied if the company has a short financial history or its size has varied due to growth or downsizing.

Furthermore, the creditors will seek clarity on the expected duration of the crisis and the expected timeline for the company to overcome the financial crisis and restore its ability to generate consistent revenue. A company’s promoters may need to back their expectations regarding the crisis duration through expert testimonies. 

To inspire confidence regarding the speed and feasibility of the recovery plan, the company must transparently admit to its existing structural issues and shortcomings while providing a plan to address these faults and position itself optimally to capitalize on the eventual market reversal.

3. Exploring operational restructuring routes

In some Chapter 11 bankruptcies, companies must wind down their operations in some locations or discontinue certain product lines. While this will allow the company to settle some debts through proceeds from asset liquidation, it has some important considerations.

Firstly, the company must estimate which locations or product lines have the potential to generate the most cash flow net of expenses. Since a crisis may affect different products or regions at different timings and magnitudes, this can be a challenging task.

Secondly, closing down locations or discontinuing certain product lines will result in layoffs. Hence, the valuation expert must coordinate with the human resources department to estimate the severance package costs across the product lines and locations, and compare that with the expected savings.

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Depending on the type of bankruptcy, the scope of the valuation exercise will either be limited to asset valuations or it may extend to cash flow projections. In a Chapter 7 bankruptcy where a company is liquidated, the primary challenge in the valuation exercise is to estimate the value of intangible assets and secure reasonable prices for fixed assets lacking active markets.

Valuing intangible assets is challenging since their value is often tied to market size, licensing potential, technological risks, and in some cases, other assets. On the other hand, assessing the value of a physical asset is challenging since it often necessitates extensive research into industry conditions and past transactions.

In a Chapter 11 bankruptcy, through valuation reports, a company must demonstrate that continuing operations will create more value for stakeholders than liquidation. Creditor skepticism about the feasibility of projected cash flows must be addressed with transparent and robust operational plans.

Other challenges include estimating the impact of economic downturns on revenue generation, addressing structural inefficiencies, and calculating costs for operational restructuring.

Since bankruptcy valuations are extremely nuanced, working with experienced professionals is crucial to navigating the challenges effectively.