What happens to your shares if a company goes bankrupt?

Key takeaways

• Shareholders are paid last, after creditors and preferred shareholders.
• In many bankruptcies common shareholders receive nothing.
• Reorganisation can keep the company alive while cancelling old shares.
• Delisted shares may trade over the counter at low prices.
• Your loss is limited to your investment unless you used leverage.

Shareholders own the company, but in a bankruptcy they are last in line to get paid. That is the main reason shares are riskier than bonds. Here is what typically happens.

The pecking order

When a company cannot pay its debts, its assets are used to pay claims in a set order. Simplified:

1. Secured creditors (lenders with collateral)
2. Priority claims such as some taxes and employee wages
3. Unsecured creditors, including bondholders and suppliers
4. Preferred shareholders
5. Common shareholders

Each level is generally paid in full before the next gets anything. Because a bankrupt company by definition has more debt than it can pay, common shareholders often receive nothing. See bond and share in the glossary.

Reorganisation vs liquidation

In the US there are two main paths:

• Chapter 11 (reorganisation): the company keeps operating while it restructures its debts. Old shares are frequently cancelled and creditors receive new shares in the reorganised company. Sometimes old shareholders keep a small stake, but often they are wiped out.
• Chapter 7 (liquidation): the business is shut down and its assets sold. Shareholders rarely get anything.

Other countries have similar concepts. In Finland, corporate restructuring (yrityssaneeraus) aims to keep the business going, while bankruptcy (konkurssi) ends it.

What happens to the stock

• Price collapse. The price usually falls sharply when bankruptcy becomes likely.
• Delisting. Major exchanges often delist the stock. In the US it may then trade over the counter, sometimes with a “Q” added to the ticker.
• Cancellation. If the reorganisation plan cancels the shares, they become worthless.

Why bankrupt stocks sometimes rally

Shares of bankrupt companies can spike on speculation, often traded by people hoping for a turnaround. US regulators have warned that buying shares of a company in bankruptcy is very risky, because in many reorganisations existing shares are cancelled. A rising price does not change the pecking order.

Can you lose more than you invested?

Not when you simply own shares with your own money. Your maximum loss is what you paid. The exceptions are leverage, margin loans and short positions.

Taxes

When shares become worthless, many tax systems allow you to claim a capital loss, but the rules on when and how vary. In Finland, for example, a loss can generally be deducted when the shares are confirmed worthless, such as at the end of bankruptcy proceedings. Check your local tax authority.

How to protect yourself

• Diversify. No single company should be able to sink your portfolio. See investment risk basics.
• Watch balance sheet warning signs: rising debt-to-equity, negative free cash flow and auditor going-concern warnings.
• Consider index funds. In an index fund a single bankruptcy has a small effect.

Preferred shares and bonds in distress

Preferred shareholders rank above common shareholders but below creditors, so they sometimes recover part of their investment when common shareholders get nothing. Bondholders often end up owning the reorganised company through a debt-for-equity swap. This is why, in a restructuring, the bonds of a struggling company can trade at a fraction of face value while still being worth more than its shares.

Common mistakes to avoid

• Buying a bankrupt stock because it looks cheap.
• Assuming a reorganisation means existing shares survive.
• Ignoring going-concern warnings in annual reports.
• Holding a large share of a portfolio in one struggling company.

Bottom line

In a bankruptcy, shareholders are paid last and often get nothing. Reorganisation can keep the company alive while still wiping out old shares. Diversify and watch the balance sheet. Learn the basics in what is a stock.

Frequently asked questions

Do shareholders get anything in a bankruptcy?

Only after all creditors and preferred shareholders are paid in full, which often means nothing for common shareholders.

Can I still sell my shares after bankruptcy?

Often yes, on the over-the-counter market after delisting, but prices are usually very low and volatile.

Can I owe money if a company I own goes bankrupt?

No, not for ordinary share ownership. Your loss is limited to what you invested, unless you used leverage.

What does Q at the end of a ticker mean?

In the US, a Q added to a ticker has indicated a company in bankruptcy proceedings.

What is a going-concern warning?

An auditor’s statement that there is substantial doubt about the company’s ability to keep operating, often a sign of financial distress.

Do bondholders get paid before shareholders?

Yes. Bondholders are creditors and rank ahead of shareholders.

Sources

• SEC Investor.gov: Bankruptcy
• US Courts: Chapter 11 basics
• US Courts: Chapter 7 basics

This article is general education, not financial, tax or legal advice. Hodlia.fi does not recommend buying or selling any asset. Check current rules and do your own research before making decisions.