Zombie companies in the hospitality industry – mitigating the credit risk
October 12, 2023
Zombie companies with negative balance sheets and surviving only through the indulgence of their creditors have long been a worrying feature of the UK economy, creating unlevel playing fields for healthy competitors and acting as a drag on GDP growth.
Our research in June 2022 revealed that there were 257,150 UK registered companies with liabilities that exceeded their assets by at least £20k in their last accounts filed at Companies House. Between them, they had a combined balance sheet deficit of £299bn and total borrowings of £900bn. Around 5.5% of all UK companies are Zombies.
Hospitality zombie companies
Our latest market sector report on hospitality published earlier this month showed that the situation is much worse than for the UK economy as a whole. There were 15,739 zombie companies, equivalent to 19% of all hospitality companies compared to 5.5% for the wider economy. They have a combined deficit of £2bn.
Are all zombies bad news?
The vast majority of zombie companies fall into three categories:
- Those deliberately funded with borrowings instead of the traditional method where owners put in their cash in return for shares. This is the preferred funding model for the private equity sector and other venture capital investors and has the effect of magnifying the investment return when the company is sold. It’s seen mainly in larger companies.
- Some owners of smaller businesses prefer to support them by giving Directors’ loans, especially when cash flow is tight or when they are expanding. Getting the money back out of the company when the funding is no longer needed is far easier than repaying equity capital, which can be a time-consuming and relatively expensive exercise.
- ‘Accidental’ zombie companies, which are forced into a deficit position by trading losses or where they have had to write down the value of assets in their books.
Although the last category is of greatest concern and the most likely to fail, the rapid rise in interest rates has brought far higher risk to the first type of Zombie as they struggle to generate sufficient cash and profits to service their debts. These also tend to be the largest of hospitality zombie companies, causing major losses for their trading partners if they fail.
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How can trading partners mitigate their credit risk with zombie companies?
Knowing your Zombie customers
The first steps are fact gathering to identify the hospitality zombie companies in the customer list, work out what type of Zombie they are and quantify the extent of their balance sheet deficit relative to their asset base.
Assessing the risk of a zombie company
The next stage is to assess:
- the degree to which the recent hike in interest rates may be impacting their ability to continue to service their debts;
- what the cost of living crisis is doing to their revenues and gross profit margins;
- what other cost increases could be doing to their ability to generate profits and cash, especially energy costs;
- whether labour shortages are limiting their ability to trade across all available opening hours; and
- future negative factors, such as the impending rise next April in business rates.
Maintaining an open dialogue
With major Zombie customers, it’s good to talk and to keep talking. Once the risk has been assessed, it’s always worth discussing your concerns with the customer and finding out what actions they’re taking to reduce the risk. This should be an ongoing dialogue.
Reducing activity levels or closing the account with the zombie company
If the risk with a zombie company is a worry, then there are various choices: tolerate the risk, tighten credit terms, cut the level of business done with the customer, or close the account altogether. These are commercial decisions, but ones which should be taken in the context of the damage a major bad debt can cause. If the profit margin with a customer is 10%, even just a £10,000 write off means doing an extra £100,000 of sales elsewhere to restore the lost contribution.
Be guided by market intelligence
Very few business failures of any size are a total surprise to the markets in which they operate, especially in the hospitality sector. Reductions in trade insurance cover should be a red flag for suppliers, invariably causing cash flow havoc at the customer. If cover is pulled altogether, there has to be a big question mark for suppliers in taking any credit risk at all.
Trade gossip can be misleading, especially if a customer is under financial pressure but, equally, it shouldn’t be ignored. Sudden departures of senior staff at a struggling customer is another negative indicator.
Taking action – and taking it quickly
Prevaricating on credit risk management just magnifies the risk. Too many major bad debts were only minor when prompt and decisive action could have been taken, but wasn’t. Delaying action could cost you money.
If you are seeking professional advice for your business, Opus is here to help. You can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.