Zombie companies are on the rise

Zombie companies are on the rise

October 7, 2021

What are zombie companies?

Just like the unfortunate creatures often seen lurching about menacingly in horror films, zombie companies are little more than a collective drain on the economy. They are unproductive corporate entities, which survive because of ultra-low interest rates and the forbearance of creditors. Zombie companies stop the clearing out of business dead wood, they hold back healthier companies and they prevent capital being recycled and reinvested, stifling economic growth in the process.

This is not a new phenomenon, but worryingly, it is a rapidly growing one. Research this month using the Company Watch database shows that there are now 261,944 UK registered companies with balance sheets that are negative to the tune of at least £10k. Between them they have deficits totalling a staggering £107.5bn, not far short of the annual NHS budget.

Look back just five years and the contrast is startling. In 2015, there were only 131,668 such zombie companies with combined negative equity of £44bn. So, the numbers have doubled and the potential shortfall has gone up by 143%. One in sixteen UK companies is now a zombie; five years ago it was one in 25.

Is this problem industry specific?

Unsurprisingly given the sector’s dominance of the economy, business and professional service businesses represent a fifth of the zombies and 30% of the deficit. Other industries with a significant zombie problem include Real Estate, Construction, Retail and Manufacturing.

The vast majority of the zombies have relatively small deficits, but there are seven with deficits over £1bn and another 11 with deficits between £500m and £999m. Then there are 17 with deficits between £250m and £499m and 43 more with deficits between £100m and £249m. All told, 78 UK companies have a shortfall of over £100m.

The cause of this escalating problem is debatable. Some of the smaller zombies may reflect owners preferring to fund their businesses with loans rather than locking in their money as share capital. Most of the larger ones are the product of the modern acceptance of private equity style funding structures, where their acquisition and then their growth is funded almost entirely by debt, much of it carrying high interest rates.

One of the largest care home chains changed hands between financial buyers four times between 1999 and 2012, with its debt mountain growing every time. It now has £1.1bn of debt and an annual interest bill of £140m to be met somehow by an underlying business that struggles to make an operating profit.

The fundamental problem with zombie companies

This shows the fundamental problem with zombie companies. The rationale for staggering on with negative balance sheets is that in good times, they can generate sufficient profit and cash flow to at least service their interest bill and maybe chip away at the loan capital itself.

But what now in the midst of a pandemic, which has severely disrupted the business models of whole industries such as hospitality, travel or aviation? The accounts on which the Company Watch research is based are mostly for periods pre-dating Coronavirus. How much worse might these balance sheets look when the next set of numbers is published?

One of the biggest zombies is an iconic British company with a long and proud heritage. Its shortfall is over £8bn. It is attempting to plug this gap with a restructuring intended to raise somewhere between £3bn and £5bn. It is fortunate that it has sufficient credibility to undertake such an exercise and its tens of thousands of employees and its legion of creditors can only hope that it will succeed. However, it will still be a zombie.

How do zombie companies threaten the economy?

This illustrates perfectly the threat to the economy from this appalling zombie phenomenon. Eventually, the £107.5bn deficit must crystalise as losses for the stakeholders in those businesses, unless and until profits can be generated and retained to reduce it. This might not happen all at once, but the carnage caused by Covid-19 is very likely to accelerate the write offs.

Of course, a proportion of zombies are simply businesses, which have hit hard times and where their losses have exhausted their capital and pushed them into negative territory. Changing circumstances may have slashed the value of their assets, such as leases on shops or restaurants, or intellectual property. There is no shame in this; it is just a fact of business life, especially in these extraordinary times.

What should business owners and directors do?

What should the owners and management of zombie companies do?  If their deficit is increasing, an eventual insolvency raises the spectre of personal liability under the wrongful trading provisions of the Insolvency Act. If there is no genuine prospect of eliminating the deficit, they are equally at risk. One thing is for sure, they should be taking independent expert advice urgently about carrying on.

If you have any concerns having read this article, please do not hesitate to contact one of our Partners for a free, confidential no obligation chat.