“Better a peaceful sleep in the earth than the life of a zombie - not really dead but not really alive, either”
For the last few years a term has been doing the rounds on Blogs, Linkedin and Twitter; Zombie companies. In November 2014 the financial times showed that there were 103,000 of them operating in the UK alone. With interest rates predicted to go up at the end of the year, the idea of doing business with a zombie company has people running scared and with good reason. Before the recession the practises of these companies, while frowned upon, was widely accepted. Over the last few years people have become more cautious as to the payment trends of their customers and the actions of these “Zombie Companies” is no longer acceptable to those who know what to look for. But what is a Zombie company and perhaps more importantly, what threat do they pose to your business?
The term “Zombie Company” seems like it has a better place in a George R Romero horror film but when you consider the definition it’s incredibly fitting. A Zombie company is a business that only pays off the interest on their liabilities. Each year they hobble onwards, making just enough to pay the interest and leaving the balance of debt untouched. As Mark Thomas, Author of Zombie Economy said, "The Company can limp along, it can survive, but it hasn't got enough money to invest." In other words it is stagnant and non-moving. There are many businesses that choose not to grow year by year due to a comfortable customer base or being happy with their current place in the market. They differ from Zombie companies though because any debt that’s been accrued is quickly paid off.
So what danger does this hold? Firstly one can only wonder at the Business model and financial plan of a company that doesn’t try to shake its debt. It could be that this is the only way for them to survive but that then begs the question of how they arrived at this point in the first place. Either way it shows a certain disregard for liabilities so starting to do business with them would be incredibly risky. Secondly, If interest rates were to rise, would this company be able to pay back all of their debt? With the Bank of England stating a potential rise in November of this year, Companies who have been solely paying off interest will find those payments rising. If the company has strong assets and shareholder funds then it shouldn’t be an issue. Although we should ask why those reserves haven’t been utilised for paying the debt in the first place? It is the companies with a negative working capital that become a serious concern. If a company’s liabilities outweigh their assets and they default on their payments, what will be left of the business once all debts are in? So when deciding to do business with a zombie company the question isn’t just "will they pay us back?" but "will there still be a company to pay us back?"
So how do you spot a zombie company?. To identify a Zombie company you go to the accounts. There are five main things to look for in a company’s accounts to spot problems; Sales, Profits, Balance, Liquidity and Liabilities. We’ll start with the liabilities. If a company is only paying off the interest then their liabilities will remain constant every year. Everything else will be changing fluently but the debt stays the same. This is the key marker of a zombie company. The other four components of the accounts show us if they are credit worthy. It should be noted that not all Zombie companies are uncreditworthy. If their sales and profits are on the rise it shows a strong promise in the company. They may not be able to pay off the full debt at present but their consistent growth would indicate that they will be able to further down the line. If this is the case and you become more inclined to deal with them then check their overall balance and liquidity.
As mentioned before, a negative working capital should be an instant red flag. However, if a company has the ability to pay off the debt after all liabilities have been taken into account, It’s probably a safe decision to start working with them.
What it really comes down to is this. You can’t judge a company based on its assets and sales. Always look at the liabilities and how they pay them. It is the weaknesses, rather than the strengths, that tell the real story.
Know who you're doing business with