Risk underwriter, Michael Hart, and Credit Analyst, Giles Senter, took time from their busy schedules to tell us about Zombie companies. It’s not the latest title from a horror movie but it could be...
What is a Zombie company first of all?
"Zombies are companies that earn just enough money to continue operating and service debt but are unable to pay off their debt. Such companies, given that they just scrape by meeting overheads (wages, rent, interest payments on debt, for example), have no excess capital to invest to spur growth. Zombie companies are typically subject to higher borrowing costs and may be just one event – market disruption or a poor quarter performance – away from insolvency or a bailout."
Figures vary on how many UK companies may actually be zombies. The general consensus level is that between 12-20% of UK businesses are zombies. With Covid and Brexit, we are facing an increasing list of economic issues, which have generated more zombies.
Here are some characteristics of a zombie company:
- weak leveraged balance sheet – majority of assets have charges against them
- interest cover is below 1.5x (EBITDA vs interest expenses)
- extended or breached credit facilities
- low/no growth
- insufficient cash/profit generation to invest in the future of the business
- poor long-term prospects
- unable to pay for itself to become insolvent – either creditors or directors of a business can pay, but insolvency fees could reduce how much creditors are able to recover
- insolvent on a statutory basis (deficit working capital)
His colleague, Credit analyst, Giles Sender, completes:
“You raise some really good points. For me, one of the big areas is how the balance sheet is leveraged. What facilities does the business have? Are they appropriate? Could more cash be squeezed from the assets? Does it look like they have exhausted all possible avenues of funding? In which case, how deep are the owners' pockets and how likely are they to support?
I often ask myself, would I fund that?”
Michael continues and lists some of the red flags:
- County Court Judgements (CCJs) – especially multiple CCJs in a short space of time
- Are there overdue payments?
- Are they asking to be paid early for work done, or for stage payments to be brought forwards (as they have insufficient cash to finance their working capital)?
- Are they focusing on cash generation rather than profit and growth?
- Are there winding up petitions from suppliers?
- Have long-term liabilities increased (this is likely due to Coronavirus Business Interruption Loan Scheme (CBILs)/Bounce Back Loan Scheme (BBILs)/Government support used)?
Here are a few things to look out for:
A common misconception is that most zombie companies are large corporations. It is more likely that an SME would be a zombie company. So whatever your customers’ size, you should be mindful of the common characteristics pointed out here. Smaller SME companies will have less access to funding and will have low asset bases to raise much-needed funds against.
On top of these read flags, Giles also advises to check things in real life. “As an on-the-road analyst, one of the most important parts of my job is going out to see a business, while this hasn’t been possible over the last year, so much is gained from a site visit.
Whilst it is rare, it is not unknown for a struggling business to provide fraudulent information (management accounts). Being on site, seeing the staff and machines working, you get a much better feeling of how it translates into the numbers in the management accounts.
It’s so important to remember, trust your gut feeling. If there is a lot of moaning, groaning and things don't seem right, chances are, it could be a Zombie.”
As the government support begins to end, you should be mindful of how these companies can survive. They are likely to struggle to finance any future growth as the global economy goes back to a more normal state (read our article ).
If these companies are one event away from insolvency, this might have serious repercussions on your own business. Could one (or several) of your partners be a zombie? A supplier, a customer, a competitors? A customer struggling could mean they are unable to pay due invoices which would in turn impact your cash flow (read our ).
Credit insurance will provide you with constant monitoring of your customer portfolio. A team of credit analysts analyse companies’ financials day-in day-out, will be able to spot zombie companies for you. You can use trade credit insurance as an early-warning system to manage your trade credit risks and avoid being caught by a zombie company.
And, if your customer fails, credit insurance will protect you by covering unpaid invoices and insolvency.