What it means
Ordinary dividends are paid out of profits that the company has earned. A liquidating dividend is different because it is funded by selling assets and handing over the proceeds, so it reduces the size of the business rather than sharing its success.
It most often happens during a winding-up, when a company sells its assets, pays its creditors, and distributes what remains to shareholders. It can also occur when a company sells a major division and decides to return the cash instead of reinvesting it.
Because creditors rank ahead of shareholders, a liquidating dividend can be paid only after debts are settled. The tax treatment is often different from an ordinary dividend.
In many countries, the first part of a liquidating distribution is treated as a return of the shareholder's original cost, which is not taxed as income, and only the amount above that cost is taxed as a gain. The details vary, so shareholders should check the rules that apply to them.
From an accounting view, the company reduces its capital accounts, not its retained earnings, when it pays one. Directors need to be careful here, since in many places paying capital out to shareholders while the company still owes money to creditors can breach company law and may make directors personally liable.
For investors, a liquidating dividend is a signal that the company has no more use for the money in its current form. It should not be read as a sign of strength, because the business is shrinking, and the share price usually falls by the amount distributed.
Investors who treat the payment as income may overstate their return from the investment. Before paying one, the board should confirm that every debt and expected cost has been covered, including tax bills, legal fees, lease obligations and claims that might still arrive.
Many companies hold back a reserve for these items and pay a second, smaller liquidating dividend once the reserve is released.
In practice
Real-world examples.
Example
A family-owned manufacturer closes after the owners retire. It sells its factory and equipment, repays the bank loan and pays the remaining $4,500,000 to its three shareholders as a liquidating dividend in proportion to their holdings. A shareholder who owns 40% of the shares receives 0.40 x 4,500,000 = $1,800,000.
Example
A listed technology company sells its main business to a larger rival for cash. The board decides there are no good uses for the proceeds and pays most of the money to shareholders as a liquidating dividend. The share price drops by roughly the amount of the payment on the day the shares trade without it.
Example
An investor in a real estate company receives a payment marked as a liquidating distribution after the company sells its last building. Her accountant treats the payment as a return of her original investment first, and a gain only for the amount above her cost. The company's statement shows her the split so she can complete her tax return.
Formula
Calculation
Liquidating dividend per share = (proceeds from asset sales - liabilities paid) / shares outstanding.
Suppose a company sells its assets for $9,000,000 and pays liabilities of $3,000,000. The amount left is 9,000,000 - 3,000,000 = $6,000,000. With 2,000,000 shares outstanding, the liquidating dividend = 6,000,000 / 2,000,000 = $3.00 per share. If a shareholder paid $2.50 per share, the gain is 3.00 - 2.50 = $0.50 per share, and the first $2.50 is a return of capital.Case study
Seen in the real world.
Larkfield Packaging is an illustrative, fictional company that decided to close after its main customer moved production overseas. The board sold the machinery for $5,000,000 and the warehouse for $4,000,000, giving it $9,000,000.
After paying the bank $2,500,000, suppliers $1,500,000 and employee redundancy costs of $1,000,000, the company had $4,000,000 left. With 1,000,000 shares in issue, the board announced a liquidating dividend of $4.00 per share.
In this illustrative case, many shareholders had bought at an average of $3.20, so they realised a gain of $0.80 per share. The company's accountant sent each shareholder a statement showing how much was a return of capital, so they could report it correctly. The board then filed the paperwork to close the company formally.
Watch out
Common mistakes.
- Treating a liquidating dividend as income from profits, when it is a return of the owners' capital.
- Paying shareholders before creditors, which can breach the law and expose directors to personal liability.
- Assuming it is taxed like an ordinary dividend, when many tax systems treat part of it as a return of cost.
Questions
People also ask.
How is it different from an ordinary dividend?
An ordinary dividend comes from profits and the business continues, while a liquidating dividend comes from capital and the business is winding down.
Can a company pay one while still trading?
Yes, if it is returning capital after selling a major division, but it must still have enough assets to cover its debts and meet any legal rules on distributions in the place where it is registered.
What happens to the share price?
It usually falls by about the amount paid out, because the company is worth less after the distribution.
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