South East: One in seven companies could be a 'zombie business'

One in seven (14%) South East companies is just paying the interest on its debts, rather than repaying the debt itself, according to new research from insolvency and restructuring trade body R3.

Only being able to pay the interest, not the original debt itself, is one potential sign of a so-called ‘zombie business’ – a company which is only surviving thanks to low interest rates but which otherwise might not be viable.

Zombie businesses are often linked to lower levels of productivity within an economy, as they do not have the available capital to invest in new operations, products, or services, while the investment tied up in them is denied to other, nimbler companies.

R3’s research, based on a survey of 1,200 companies across the UK by research firm BVA BDRC, also found that other signs of acute business struggles are relatively widespread. More than one in six (17%) businesses in the South East are having to negotiate payment terms with creditors; 7% are struggling to pay their debts when they fall due; and 9% would be unable to repay their debts if interest rates were to increase by a small amount.

Mike Pavitt, chairman of R3's Southern Committee and partner and head of the corporate restructuring and insolvency group at Paris Smith in Southampton, said: “Tougher trading conditions and much uncertainty over the future of the economy have contributed to a significant chunk of businesses in the South East finding themselves stuck in ‘zombie business’ mode.

“These businesses are capable of ticking along, but growth and increased productivity improvements are out of their reach for the time being. On the one hand, this means thousands of businesses are stuck in a position where they’ll struggle to deal with external shocks. This presents a problem if they all were to become insolvent at the same time. On the other hand, you have a significant proportion of businesses which are tying up investment and staff which could be used by more productive companies elsewhere in the economy.”

Pavitt added: “R3 members have reported that economic uncertainty is contributing to businesses treading water, with some building up stock to safeguard against future risks – such as the UK leaving the EU without a deal in March. Investing in the stockpile puts pressure on cashflow and investment in other areas, while large stockpiles will take time to turn back into cash and are at risk of obsolescence.

“Rising interest rates will have also contributed to businesses stumbling into ‘zombie business’ status.

“The future for these ‘zombie businesses’ is mixed. Some might eventually be able to restructure or find new investment, and grow. Others will run out of road and become insolvent. While this would mean capital could be ‘recycled’, it may also be a bit of an economic shock in itself.”

Positively, the UK’s insolvency and restructuring framework is highly rated by the OECD for its zombie-busting powers, and the Government recently announced plans to improve the UK’s business rescue and restructuring options.

Pavitt commented: “While they still need a lot of work, the Government’s insolvency reform proposals could give insolvency practitioners more tools to help turn around struggling companies, and boost productivity.”