When you're deciding whether to hold a bankruptcy claim or sell it on the secondary market, you need a way to value it. Claim valuation is both art and science, blending hard numbers with judgment calls about recovery probability and timing.
The Basic Valuation Formula
At its core, claim valuation is straightforward:
Claim Value = Face Amount × Recovery Rate × Discount Factor
Face Amount
This is the amount you're owed—the principal debt plus any accrued interest and documented fees allowed by law.
Recovery Rate
What percentage of your claim will you actually recover? This depends on the debtor's assets, the case type (Chapter 7, 11, 13), and your claim's priority. A secured claim against substantial collateral might have a 90–100% recovery rate. A general unsecured claim against a small business might have a 5–20% recovery rate.
Discount Factor
Bankruptcy cases take time—sometimes years. A dollar recovered in 3 years is worth less than a dollar today. Discount factors account for the time value of money and the risk the case gets worse (additional disputes, plan modification, etc.). A reasonable discount factor is 10–30% per year of expected recovery time.
Example Calculation
You have a $100,000 unsecured claim against a Chapter 11 company. Based on the company's balance sheet, you estimate a 40% recovery rate. The case is projected to take 2 years. Using a 15% annual discount factor:
- Face Amount: $100,000
- Recovery Rate: 40%
- 2-Year Discount (15% × 2): 30%
- Calculated Value: $100,000 × 0.40 × 0.70 = $28,000
You might offer to sell this claim for $25,000–$28,000, depending on urgency and market conditions.
Key Valuation Factors
1. Claim Priority
Secured and priority claims recover more. General unsecured claims recover less. Know your claim's place in the waterfall.
2. Estate Size
Larger estates mean more assets to distribute. A $10M estate supporting 1,000 claims is better than a $1M estate supporting 1,000 claims.
3. Case Type
Chapter 7 (liquidation) is typically faster (6–12 months) but smaller recovery. Chapter 11 (reorganization) takes longer but can yield higher recovery rates if the business is reorganized successfully.
4. Debtor Industry and Timing
A bankruptcy in a cyclical industry might benefit from a market recovery. A startup in a contracting space might not. Market sentiment matters.
5. Litigation Risk
If the claim is disputed or contested, recovery is less certain. Factor in the cost and risk of litigation.
Market Benchmarks
In the secondary market, claims typically trade at:
- Secured claims: 80–100% of face value (low risk)
- Priority unsecured claims: 60–90% of face value
- General unsecured claims (liquid estate): 40–80% of face value
- General unsecured claims (illiquid estate): 5–40% of face value
- Distressed/contested claims: 1–20% of face value
Valuation for Sellers vs. Buyers
As a seller, you want to price high (optimistic assumptions about recovery). As a buyer, you price low (conservative assumptions). The market price reflects the negotiated middle ground.