Zombie companies - Are they holding back UK economic growth?
The term "zombie company" has been in the press over the last few years and even Radio 4 ran a piece about them on file on 4. Click the link to hear the programme.
The issue came to the notice of the press since Jon Moulton of Better Capital started to say that these companies were a drag on economic growth.
The number of zombie companies has recently dropped significantly, indicating there are more financial options for businesses - see our news piece on the subject.
So what is a "zombie company"?
A zombie company is simply a company that is neither dead or alive. In other words, it is in so much debt that any cash generated is being used to pay off the interest on the debt or not actually reduce it, they have cut back as much as they can. This means that there is no spare cash or capacity for the company to invest or grow. This means that is unable to employ more staff but on the flip side as long as the company is not actually losing money on an operational basis it does not need to make further redundancies either.
Many economists are arguing that the presence of some estimated 150,000 of these companies are taking market share and locking up talent that should be available to more dynamic and less indebted firms.
The statistics are pointing towards this "zombie phenomenon". Insolvency statistics were showing a much lower than expected failure rate a year ago compared to the last recession, unemployment is lower than expected but productivity is also low. The growth in the economy is recovering, however if interest rates rise, SMEs may struggle.
How come there are so many of these firms?
There are 3 obvious reasons.
Interest rates have been very low for some time now so if you are in debt then interest rate payments are pretty low as well. What is more, interest rates have remained stable. This has given the impression that there is no crunch round the corner and has allowed companies to extend and pretend.
New liquidity rules and the presence of the Special Liquidity Scheme, and other lending initiatives, means that banks are reluctant to call in loans.If the banks really want to lend to companies then they can go cap in hand to the Bank of England. What is more asset values are depressed and there are not many buyers out there so some banks will wait before calling in administrators in the hope that any recovery will be better in the future.
HMRC and the Government
HMRC have been concentrating on trying to get tax from companies and individuals that are evading tax. You only have to read the recent furore about Vodafone, Google, and Starbucks, to see where the political pressure is. It is right that evasion is tackled but the HMRC have not been very tough on companies that are trading but are building up tax liabilities that they are unlikely to be able to recover. The government are also preferring the devil they know scenario. They do not want to "rock the boat" as it were so there is a bit of a culture of indecision. They worry, perhaps correctly, that any radical action is going to cause short term pain and hence destabilize the coalition....
Are you a zombie company and what should you do about it?
Simply, you need to ensure that your debts are paid off quickly, repayments are reduced, or a proportion of them are written off. This will allow you to grow. If you are beginning to run up unsecured debts, ie trade creditors and HMRC then you need to act and perhaps a CVA or a Plan A could be an option.
What are the risks?
Any sudden change in the business or economic environment could be the catalyst for change. An increase in interest rates is being touted as the likeliest "zombie killer" but a change in the banks or Government's attitude to these companies could be equally dangerous. A strong improvement in the economy could also be their deathnell as quicker and more nimble companies will take advantage of the new opportunities presented leaving the zombies behind.
The main thing about interest rates is that it will affect thousands of people on mortgages as well which will depress demand for companies goods and services so "zombies" will be hit by a double wammy!
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Please note that the guide was mostly written pre Covid-19 and there have been some changes to insolvency legislation that limits creditors actions and relaxes rules regarding wrongful trading. A new 20 day moratorium for distressed businesses has also been introduced.