How to Avoid zombie companies in insolvency
In economic terms, a zombie company, also known as a zombie corporation, is simply a business that needs financial rescue from the bank to stay alive, or a company that is so far in debt that it can not pay back the loan on its own debts but not pay the principal on the existing debt. Often, zombie businesses are created by mergers and acquisitions where multiple companies which are experiencing financial distress are absorbed by larger, more stable companies. Although these transactions are considered to be fairly sound business deals, they can often lead to zombie companies that have absolutely no chance of ever returning to profitability. While mergers and acquisitions are a popular method of creating wealth for stockholders, they have been used to create large concentrations of debt that make it impossible for these businesses to ever pay back their creditors, much less become a profitable company.
As the global economy suffered through the 2021 financial crisis, more companies found themselves unable to remain solvent, and many were shuttered. The world’s most productive economies were literally paralyzed by the crisis, and many economies were forced to adopt policies of fiscal stimulus in order to prevent even more job losses and damage to the economy. This is when the term zombie company was first coined. As the zombie companies refused to pay their debts, it became a term referring to the failure of these companies to make payments to their creditors.
Zombie Companies: Bank Failures and Liquidations
The term zombie company has a much different meaning today. Instead of referring to a dead business, it now refers to financial institutions that are facing the possibility of not being able to service their own debts any longer. Creditors of these companies include banks, credit unions, mortgage companies, investment banks, and credit card companies. While there is still hope for these companies to continue operating until they can begin to pay their debts, the recent string of bank closures and liquidations has put them into survival mode and it is only a matter of time before the remaining assets are depleted.
Typical symptoms of a zombie company include:
- A lack of profitability, and/or an inability to pay its debt obligations in the near term.
- The absence of consistent cash flow from operations or long-term capital investment.
- Poor financial management – including the failure to provide timely disclosure information, maintain proper records, or comply with securities regulations.
- Debt restructuring efforts are not successful because they result in unsustainable levels of continued borrowing by the company. This is often evidenced through insider trading activity (i.e., hedging) on debts senior to equity as well as unusual transactions such as large quantities of stock being sold at discounted prices within short periods during a fiscal year when there was no significant business.
While there are many potential reasons why a zombie company fails to meet its debt obligations, the most common reason is poor cash management. If the business is growing and has enough revenues to pay its debts, but fails to make required monthly payments on its debt, then the owners are in danger of becoming delinquent on the debt. Once a business becomes delinquent on its debt, it is difficult for it to return to profitability, causing the business to shut down. In many cases, if the owner is unable to repay the debts, then the business is “simply taken over” by another company.
The best option when you are a business that has reached this point in its history is to consider going through the process of insolvency. Many businesses choose bankruptcy because it allows them to get rid of past debts without having to deal with an unanticipated liability. Bankruptcy is also often a quick solution when faced with serious debt problems. However, if you have reached the age of majority, you are officially retired from the business, and if you are a debtor, you owe it to yourself to consider filing for voluntary liquidation. Liquidation occurs when the administrators of an insolvency proceeding to sell the assets of the company to pay off the creditors.
In economic terms, a zombie company, also known as a zombie corporation, is simply a business that needs financial rescue from the bank to stay alive, or a company that is so far in debt that it can not pay back the loan on its own debts but not pay the principal on the existing…