Death of the Zombies

Recent data shows that corporate insolvencies are at their highest level since the 2009 crash and voluntary liquidations are happening at the highest rate since records began. The economic situation has been and continues to be challenging but businesses have already come through Brexit, COVID and the invasion of the Ukraine with the resulting massive increase in energy costs. So why, now, when interest rates are falling, energy prices are dropping and inflation is easing, is the rate of insolvencies rapidly increasing?

The answer to that is the death of the Zombies. Zombie companies are companies that like zombies in the movies are not alive or dead, they are just going through the motions whilst adding nothing to the economy and just like on the big screen there are different kinds of zombies – all scary:

Debt Zombies

Debt Zombies are companies with reasonable debt levels that make enough to pay the interest but not to pay off the debt itself. Often Lenders understand the borrower is a zombie, it will fall behind on payments and catch up later but it is in the Lenders interests to continue to collect payments rather than force the company into insolvency and have to write off the debt.

Cash Zombies

Cash Zombies are companies that run at a loss consistently and survive by getting cash in from investors periodically. Often in smaller companies the cash comes from existing shareholders who do not want to lose the investment they have already made and believe in the product/service being developed by the Company.

COVID Zombies

COVID Zombies are the “latest” version of zombies, companies kept alive by the COVID grants and low interest loans received from the Government during the pandemic.

While during turbulent times it can appear that companies staying in business even when they are not profitable or successful is a good result, in fact just like on screen like zombies are dangerous to the rest of us. The zombies use up valuable resources – credit, talent, investment, and materials which are not then available to growing businesses meaning they cannot expand as quickly or contribute as much to the economy as they could do. The effect of too many zombie companies is to restrict economic growth which leads to lower tax revenues, all of which is problematic.

So why are the Zombies dying now?

The answer to that is higher interest rates. 

The Debt Zombies cannot easily cope with rises in interest rates. When money was more or less free, even marginally profitable companies were viable so the undead were able to continue to exist. Having to refinance at much higher rates as term loans fall due is killing off the Debt Zombies.

The Cash Zombies are now struggling to raise funds as higher interest rates mean that finding a safer home for available funds which provides a reasonable return is no longer difficult to do. If investors cannot be found then the Cash Zombies have to focus much more on cash generation and if they don’t then they die.

The Covid Zombies who got free grant money or loans on uncommercial terms are also finding funding working capital expensive so again unless they are able to become more financially disciplined they are failing.

Insolvency statistics always lag behind reality. In addition directors often take time to face the fact that their company is insolvent, they have overcome many obstacles to grow their businesses in the first place and the characteristics needed to do that often mean they find it difficult to accept their business is no longer viable. For those reasons the statistics are likely to get worse before they get better. Even if economic conditions were to improve, which seems unlikely in the short term, there are still a lot of zombies out there coming to terms with the new economic realities – higher interest rates, higher costs and more red tape, these are all just waiting to be killed off.

What we need now is for the business birth rate to go up and to replace the zombies with new unicorn and gazelle companies, quick growing, high value businesses. Our policy makers need to do all they can to encourage these to secure a more positive economic outlook for us all.

Disclaimer 
The matter in this publication is based on our current understanding of the law.  The information provides only an overview of the law in force at the date hereof and has been produced for general information purposes only. Professional advice should always be sought before taking any action in reliance of the information. Accordingly, Davidson Chalmers Stewart LLP does not take any responsibility for losses incurred by any person through acting or failing to act on the basis of anything contained in this publication.