Over one in ten (11%) UK companies is just paying the interest on its debts, rather than repaying the debt itself, according to new research from insolvency and restructuring trade body R3.

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.

Zombie businesses are often linked to lower levels of productivity within an economy, as they do not have the available capital to invest in new operations, products, or services, while the investment tied up in them is denied to other, nimbler companies. 

R3’s research, based on a survey of 1,200 companies by research firm BVA BDRC, also found that other signs of acute business struggles are relatively widespread. One in six (16%) businesses are having to negotiate payment terms with creditors; one in ten (12%) are struggling to pay their debts when they fall due; and 8% would be unable to repay their debts if interest rates were to increase by a small amount.

Stuart Frith, President of R3, says: “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.

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

Stuart Frith adds: “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 next 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 in itself.” 

Positively, the UK’s insolvency and restructuring framework is highly rated by the OECD for its zombie-busting powers, and the Government recently announced plans to improve the UK’s business rescue and restructuring options.

Stuart Frith comments: “While they still need a lot of work, the Government’s insolvency reform proposals could give insolvency practitioners more tools to help turn around struggling companies, and boost productivity.”

Other business distress signs slightly higher

R3 also tracks more general signs of business distress, and has detected an increase in these signs from earlier in the year.

Three fifths (60%) of businesses (up from 57% in April) reported that they have recently experienced at least one of the following: being owed payment on invoices that are over 30 days past due (20%), a reduction in sales volumes (16%), decreased profits (16%), regularly using the maximum overdraft facility (13%), or having had to make redundancies (12%).

Conversely, signs of growth tracked by R3 have dipped from April. Two thirds (67%) of businesses (down from 69% in April) said they had seen at least one of the following signs of growth: an increase in sales volumes (25%), investing in new equipment (22%), increased profits (21%), market share has recently grown (17%), or the business is expanding, i.e. geographically, increasing staff numbers or new areas of business (17%).

Stuart Frith comments: “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 blind-sided 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 determine the best way forward.”