Business Failure Rates - ​Will the UK’s economic recovery lead to an increase in failure rates?

As the UK’s economy picks up pace, in comparison to our European counterparts, it is evident that the country will face a new set of challenges which it didn’t following previous recessions; that being a shortage of access to cash/funding and the rise in the level of the number of “Zombie” firms operating within the UK.

The Zombie phenomenon first rose up from the grounds in the 1980’s and 1990’s when the U.S. savings and loan associations and Japanese banks managed to blunder along as a result of access to cheap money.

In the UK, the term Zombie is now often used to describe a company that is loss making which, currently being helped by low borrowing costs, can only just manage to service their debts.

In fact, money is so tight in these companies that even a slow month of trade can result in the failure of that business. These Zombie firms also have significant negative balance sheets; i.e. where their liabilities exceed their assets.

Whilst historically following a recession there would be a clearing out of the “dead” post-recession, this has not occurred and as a consequence the number of Zombie firms has dramatically risen by over 219% since 2009, according to Company health
monitoring specialists Watch.

It is estimated that the total amount of negative equity accumulated within these companies is now nearing £72billion, up from £69billion last year. This is currently 231% higher than in 2009, when the combined deficit was around £31billion. This all makes for stark reading and demonstrates the inordinate number of firms contained within the economy which traditionally would not have survived the recession.

Even more interestingly, within the owner managed arena in which I work, there appears to be a growing trend in smaller firms where interest on debt is being paid personally either by the Directors’ (increasing existing director loan accounts) and/or existing
shareholders. This effectively props up the failing business and simply results in a deferment of the inevitable failure, as opposed to being part of any long term strategic plan. This action also creates a situation whereby the personal wealth of the directors and shareholders becomes depleted and in some instances, once the corporate failure crystalizes, can lead to their own demise leaving
them with their own personal solvency concerns.

Unfortunately, even in the current improving economy, the prospects for the future of Zombie companies does not fair much better as these companies cannot take advantage of the opportunities for growth, when compared to those that have businesses have already
weathered the storm, become more lean and streamlined and are already in a far better financial footing.

As turnover increases, so does the need for available working capital in order to fulfil orders and cash flow is squeezed even further. Lenders will be reluctant to either increase or provide new facilities without adequate security, which is set against a backdrop of a large proportion of the Zombie firms that are already being financially stretched, with limited access to unencumbered resources.

The consequence of this is that whilst the overall financial conditions within the UK market will improve, and hopefully will provide for an increase in the number of both employment and trade opportunities within the economy, the strains placed on those silent Zombie firms tinkering on the edge of failure will be driven further by a fierce competitive downward price pressure, led by similar struggling firms who will offer anything to secure new work. Unfortunately, only those firms able to secure sufficient working capital will survive.

Again, for those existing Zombies, access to finance, well the inability to obtain that finance will ultimately be the undoing of those firms.

Furthermore, I also have a deep suspicion that as the residual values of assets improve, lenders will be looking closely at their existing banking facilities and in some instances may look to re-bank troublesome or Zombie clients’, or in some extreme situations this may result in facilities being reduced or even totally withdrawn. This is not an improbable scenario as banks will look to put their
“house” in order and to clear out the rot, albeit and as previously suggested, this will likely be deferred until the residual values rise.

So whilst improving economic conditions are welcomed and are long overdue, it is evident that this will place further and differing strains on those already groaning entities who will be faced with the problem of trying to secure both new work and funding, but unfortunately, I suspect that for many of the Zombie firms out there, that the path out of recession will be the final nail in the coffin.

In the event that you wish to discuss any aspect of the above article, or in fact you have a client who may benefit from an initial, free, without prejudice discussion, please call Anthony Ford on 01202 830 002 who will be more than happy to deal with your enquiry.