Zombie firms choking off economic renewal

Low interest rates and accommodating banks are propping up firms that should have gone to the wall long ago. UK economists say such companies hold back economic recovery.

FT.com

"Zombies” has become a new business buzzword. It describes the thousands of small but barely-alive companies that are only surviving because interest rates are low and creditors, including the tax man and the banks, are forbearing.

These companies can just about service their debt and pay their workers, but little more. They can’t expand and, by clogging up the market, they prevent their rivals from doing so, too. Billions of capital is tied up in these companies.

Banks tolerate them because they do not want to crystallise bad debts, while HM Revenue & Customs is under political pressure not to pull the plug on employers and put their workforces on to the street. Other creditors – including customers and suppliers – would rather the zombies staggered on, as they would prefer some return from them, rather than nothing.

As a result, companies that at any other time would have gone to the wall are surviving.

The good news from this is that people keep their jobs. The downside, however, is that zombies stand in the way of economic recovery, according to economists. In the past, these companies would have gone under and their surviving rivals would have mopped up their market share, fuelling the economy’s expansion. Not this recession, though. Richard Fleming, UK head of restructuring at KPMG, says "this recession is not playing out in the normal way”.

But for some zombies, death must eventually come – at least, that’s what corporate restructuring specialists now forecast. They expect insolvencies among small companies to increase in 2013.

Matthew Tait, a partner at BDO, says: "The closer they get to the consumer, the more difficult it gets.”

Insolvency practitioners expect most of the corporate failures next year to involve small property and construction companies, and those in the retail, leisure, hotels and nursing home sectors. Unless consumer confidence and spending picks up - whether on the high street or in the bowling alley – companies will fall under the weight of slowing sales and rising costs, they warn.

For many of these businesses, their downfall will be the cost of their premises – particularly where they rent property on long leases with upward only rent reviews.

Small hotel groups, particularly those operating outside the main cities, are already struggling with high fixed costs, low occupancy levels and the constant need to refurbish to attract customers. Private nursing homes, many of which rely on local authorities to refer patients, will also strain to maintain occupancy levels as authorities impose budget cuts and either reduce the price they will pay, or put referrals on to the back burner.

These businesses have the high fixed costs of staffing and complying with regulation, as well as property costs.

However, construction could be hit worst of all, warns Tait. For many, the pipeline of major building projects is drying up. And the length and complexity of existing projects, involving contractors and subcontractors, means that the failure of one part of the chain often pulls down the rest.

Small businesses in other sectors can sometimes get enough cash to tide them over by borrowing against specific assets – leasing out assets or turning to invoice discounters, which will advance them a proportion of the value of unpaid invoices. These options are rarely available to the construction sector.

Mr Fleming of KPMG says the rate of "retail busts” next year will be lower than in 2012. But that is not because conditions are any better, he says. It is simply because the rate of failure was so high in the first quarter of 2012. Government statistics show 135 retailers and wholesalers went into administration between January and March 2012 – the highest level since the first quarter of 2009, when 234 companies went under.

Freddie George, retail analyst at brokers Seymour Pierce, says there are still a lot of high-street chains with too much debt which are on the edge of failing, "but a lot of the obvious ones have gone”.

Perhaps perversely, the trigger for going under can be an uptick in economic activity. A zombie might win a big order from a customer, requiring higher levels of working capital, just as its lenders lose patience.

Sometimes, though, zombies don’t fall under the weight of their debt, they just slowly run out of energy. Julie Palmer, a partner at restructuring specialists Begbies Traynor, says businesses can struggle on but find themselves overcome by "director fatigue”.

Either way, when the march of the undead comes to a halt, the insolvency practitioners walk in.

Copyright the Financial Times 2012.

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