Asset stripping – definition and meaning
Asset stripping refers to buying a company and then selling it in bits. Asset strippers acquire businesses whose collective net worth are less than the value of their *individual assets. They then sell off the acquired companies’ assets separately.
** In this context, the ‘individual assets’ could be equipment, property, buildings, client lists, or the brand name.
In the business world, we call the asset stripper a corporate raider.
Asset stripping is similar to buying a car and then selling off its parts separately. Corporate raiders are the metal scrap dealers of the mergers and acquisition world.
The corporate raider sells off the assets of the firm it acquired to repay its debts. Its debts often increase because it needed to borrow to carry out the acquisition.
Asset stripping is a strategy that some businesses use to repay their debts. Not only do corporate raiders pay off their debts, but their net worth also increases.
Asset stripping is like buying a large log, chopping it into small pieces, and selling them off as firewood.
We use the term ‘asset stripping’ in a derogatory sense because it is not productive to GDP. GDP stands for gross domestic product.
Asset stripping is a serious problem in emerging economies that are making a transition to capitalism. For example, in China, managers of state-owned businesses sold the assets they controlled and left behind massive debts. The state then had to deal with those debts.
In fact, Russia’s current economic problems are partly due to rampant asset stripping after communism collapsed.
Example of asset stripping
Imagine a company called John Doe Inc. has three completely different businesses: shipping, gyms, and furniture. Experts have valued John Doe at $150 million. However, Vultures Ltd. believes it could sell the three businesses for $70 million each. Vultures Ltd., a corporate raider, sees an asset stripping opportunity.
Vultures Ltd. then acquires John Doe Inc. for $150 million. The corporate raider then sells John Doe’s three businesses separately, for a total of $210. Vultures Ltd. thus makes a profit of $60 million.
Asset stripping and fraudulent activity
The UK’s Serious Fraud Office defines asset stripping as taking a firm’s funds or assets of value but leaving behind the debts.
A firm’s directors transfer the valuable assets of one company to another but leave the liabilities behind. In fact, the directors leave behind a dormant company that must go into liquidation. The company cannot pay off its massive debts.
According to the Serious Fraud Office, there are two main reasons for stripping a company’s assets:
“1. The fraudsters deliberately target a company or companies to take ownership, move the assets and then put the stripped entity into liquidation.”
“2. ‘Phoenixing’ – directors move assets from one limited company to another to ‘secure’ the benefits of their business and avoid the liabilities. Most or all the directors will usually be the same in both companies. This usually arises as a way of ‘rescuing’ the assets of a failing business rather than targeting a company.”
Oxford Dictionaries describes asset stripping as:
“The practice of taking over a company in financial difficulties and selling each of its assets separately at a profit without regard for the company’s future.”