‘Zombie companies’ is a term increasingly used by financial professionals, business owners and lawyers, as they have emerged as a growing concern. These companies generate just enough revenue to cover their interest payments but lack the ability to pay down the principal of their debt or invest in growth. They are seen as symptomatic of deeper financial issues within the economy. Their existence not only reflects the struggles of individual businesses but also highlights broader economic challenges, such as prolonged low interest rates and the aftermath of the recent crises which have plagued the UK economy.
Recent data indicates that the prevalence of zombie companies is on the rise, particularly in mid-market sectors. For example, in the UK, it was reported in March 2024 that 12.4% of mid-market businesses were at risk of becoming zombie companies, a slight in - crease from 12% in the previous year. This uptick reflects ongoing challenges such as global financial instability, rising interest rates, and sluggish economic growth, all of which have exacerbated the conditions that allow zombie companies to persist.
Causes of Zombie Companies
Several factors contribute to the existence and persistence of zombie companies. One of the primary causes is the prolonged period of low interest rates that characterised global financial markets for much of the past decade. Low interest rates make it easier for struggling businesses to service their debt, as the cost of borrowing remains relatively low. However, this also means that companies that would otherwise be forced to restructure or exit the market can continue operating without making the necessary adjustments to improve their financial health. Another significant factor is the approach taken by creditors, including banks and other lenders. In many cases, lenders are reluctant to push struggling companies into administration or liquidation, particularly if there is a chance of recovering more of their debt by allowing the company to continue operating. This tendency towards forbear - ance, where creditors give companies more time or better terms in the hope of eventual repayment, can enable zombie companies to survive for longer than they might otherwise. Government policies and actions, particularly those related to taxation and regulation, also play a role. For instance, while tax authorities may crack down on tax avoidance, they may also provide companies with some leeway in meeting their tax obligations through negotiation and payment plans. This can prevent companies from facing immediate closure due to tax debts but may also contribute to their ongoing financial distress.
What is a Zombie Company?
A zombie company is characterised by its inability to generate enough revenue to do more than service its debt interest, rather than making progress in repaying the principal. These companies continue to operate, but their financial state prevents them from investing in expansion, innovation, or even necessary operational improvements. Essentially, they are in a state of limbo— neither thriving nor failing outright. While they may not be in immediate danger of liquidation, their long-term viability is highly questionable. Zombie companies are in a Catch-22 situation. They lack the financial resources to invest in growth, such as hiring new employees or upgrading technology, yet they also cannot afford to downsize effectively. The absence of funds for redundancy payments, for instance, leaves them unable to reduce workforce costs, which might otherwise help them stabilize financially. This stagnation not only affects the companies themselves but also has broader economic implications. Zombie companies can stifle competition and innovation by occupying market space that could otherwise be used by more dynamic and profitable enterprises. Economists argue that these companies contribute to a drag on overall economic productivity, as they consume resources that could be better utilized elsewhere.
THE LEGAL CORNER MAGAZINE | ISSUE 009 OCTOBER '24 | HALLOWEEN EDITION HB 14
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