Insolvency and ‘zombie businesses’

Insolvency and ‘zombie businesses’

What is a ‘zombie business’? And how did AIM-listed companies fare in 2018?

For AIM-listed companies and so-called ‘zombie businesses’, complications with insolvency had an increased impact in 2018.

“Loss making” AIM companies a cause for concern

According to UHY Hacker Young, there has been a sharp jump in the number of companies forced off the AIM junior stock market due to insolvency; 16 AIM companies in 2018, as opposed to nine in 2017.

UHY Hacker Young has reported an increased nervousness amongst investors, thus means that it is far more difficult for “loss making” AIM companies to raise additional finance by selling shares.

The firm stated: “Loss making AIM companies often have secondary fundraising on AIM, after their IPO, in order to fund themselves until they are cash generative.”

However, as of the last quarter of 2018, the AIM market endured a 23% fall. The global sell-off in stock markets meant that investors were far more aggressive when marking down early stage companies.

Laurence Sacker, managing partner at UHY Hacker Young, said: “Investors are now more nervous of providing extra funding to keep some of the financially weaker AIM companies going—it’s an inevitable consequence of stock market volatility.”

The sharp decrease had a further knock-on effect; it damaged the confidence of those investors who were asked to fund AIM businesses with “a rapid cash burn”, or those that have made previously slow progress towards breaking even.

Sacker continued: “A good AIM company will be able to raise further funds in all but the toughest of markets, but a more marginal company will find it much harder to issue shares at the moment. Investors are trying to reduce their exposure to smaller, riskier companies.

“In an overall weak economy, banks and other lenders are also looking more closely at whether they want poorly performing borrowers drawing down further tranches of loans, and that is adding to the pain of some AIM companies.”

Furthermore, Sacker cited the collapse in oil prices as a factor that has affected “investor sentiment” towards core AIM sectors, such as energy and mining.

In 2017, 50 companies were delisted from AIM for reasons other than simply being taken over. However, as of 2018, this number has risen to 52.

UHY Hacker Young has provided various reasons why companies have been delisting from AIM:

  • 5% of delistings in 2018: choosing to delist from AIM in favour of another stock market.
  • 12% of delistings in 2018: company lost its Nomad—something they need when maintaining an AIM listing. However, as there is a lower profitability amongst Nomads (partly due to Mifid II), some Nomads have dropped less risky or remunerative AIM clients.
  • 6% of delistings in 2018: being promoted to a listing on the main market of London Stock Exchanges.
  • 6% of delistings in 2018: reported that AIM’s costs and compliance burden is too high.
  • 17% of delistings in 2018: their company strategy failed.

On the subject, Sacker concluded: “Overall, 2018 has been a good year for AIM, with the market really growing in stature, and the new corporate governance code for AIM companies is an important part of that. However, the last quarter has been particularly tough—in share price performance alone it has been one of the worst in the last five years.”

‘Zombie businesses’ linked to lower levels of productivity

R3 has revealed their research based on BCA BDRC’s survey of 1,200 companies, looking into ‘zombie businesses’; they have revealed that as many as one in ten UK companies could be classified in this way.

11% of UK companies are only managing to pay the interest on their debts, rather than paying off the debt itself, the trade body has reported.

R3 summarised the term ‘zombie business’ as: “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.”

Stuart Frith, President of R3, said that “tougher trading conditions and much uncertainty over the future of the economy have contributed to a significant chunk of UK businesses finding themselves stuck in ‘zombie business’ mode.”

Zombie businesses are often linked to the lower levels of productivity within an economy; they do not have the available capital to invest in new operations, products, or services, thus allowing for stagnation. “[T]he investment tied up in them is denied to other, nimbler companies,” R3 said.

BVA BDRC’s survey also found other signs of widespread acute business struggles. For example, of those UK companies who took part in the survey, 16% of them are currently having to negotiate payment terms with their creditors. A further 12% are struggling to pay debts when they are due, and 8% admitted that they would be unable to repay debts if interest rates were to increase by even a small amount.

Frith continued: “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 will struggle to deal with external shocks. This presents a problem if they were to become insolvent at the same time. On the other hand, you have a significant proportion of businesses that are tying up investment and staff that could be used by more productive companies elsewhere in the economy.

“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.”

Nonetheless, the OECD rates the UK insolvency and restructuring framework very highly for its ‘zombie-busting powers’. The government has also recently announced plans to improve the country’s business rescue and restructuring options. This would allow insolvency practitioners more tools when assisting struggling companies, as well as helping to boost productivity.

There have been more overarching signs of business distress, R3 has further stated. 60% of businesses, according to R3, have reported that they have experienced at least one of the following:

  • 16%: a reduction in sales volumes.
  • 20%: owed payment on invoices over 30 days past due.
  • 13%: regularly using maximum overdraft facilities.
  • 16%: decreased profits.
  • 12%: had to make redundancies.

Frith concluded: “It’s worrying that business distress signs are ticking up, while growth signs are trending downwards. With uncertainty coming at them from several vectors, businesses need to stay on their toes and ensure they’re in shape to meet the future demands of the market, and customers’ ever-higher expectations.

“Any business can be blindsided by a sudden change in its operating environment; longer-term and more gradual changes must also be monitored carefully, to avoid the risk of stagnation. In a distress scenario, the perspective of a third-party advisor can be invaluable for helping directors determined the best way forward.”

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