A steady increase of 'zombie’ companies in the UK mid-market – the latest update

March 2024

• 12.4% of the UK’s mid-market are ‘at risk’ of being or becoming a ‘Zombie’
• Our analysis shows this is a slight increase of 0.4 percentage points since Summer 2023, but that it is as part of an upwards trend over the last 18 months
• Half of the businesses that were previously identified as ‘at risk’ and that have dropped out of our sample are either inactive or showing greater signs of distress
• The South East, Greater London and West Midlands regions have the highest proportion of ‘at risk’ businesses
• A decade of historically low interest rates has enabled underperforming companies to limp on without being restructured
• Companies that are currently at risk with low profitability and high debt burdens need to address their resilience and take action

Our tracker continues to assess the number of businesses within the UK mid-market that are ‘at risk’ of being or becoming ‘Zombies’. A decade of low interest rates and high debt burdens have fuelled this phenomenon, and it is likely to be detrimentally impacting the UK’s productivity and economic growth.

What is a ‘zombie company’?

‘Zombies’ are companies that generate just enough cash to continue operating and service their debt but not to invest in growth. In the current economic climate, there is growing concern amongst commentators that historically low interest rates have been enabling underperforming companies to limp on without being forced to restructure.

These low interest rates and the potential willingness of lenders to show forbearance to unprofitable companies is said to be damaging productivity and undermining competitiveness.

The above, coupled with high inflation eating away at margins and testing what are historically sound business operating models, is resulting in reduced confidence, weakening recovery plans and, importantly, is testing the resolve of lenders.

Navigating this landscape will be a challenge and restructurings are likely to be common. This will not only impact jobs in individual firms, but it will also affect businesses in the interconnected supply chain and local economies.

Despite the challenging environment, there will be an opportunity for strong and well-run businesses to consolidate their market positioning, embed resilience and take advantage of a fragmented outlook.

We continue to define a business as ‘at risk’ if both of the following criteria are met:

The latest trends – what’s changed?

Having analysed businesses in the £10m to £500m turnover bracket, we found that 12.4% could be deemed ‘at risk’ of being or becoming a ‘Zombie’. This is from a total population of 15,600 businesses that have been reviewed, up from our previous study of 15,000.

A concerning trend is that there has been a steady but consistent uptick over the last 18 months. Our latest tracker shows an increase of 0.4 percentage points from May 2023.

The likely cause of this increase in ‘at risk’ businesses is the continued global financial instability that has stemmed from COVID-19, the energy crisis, weak productivity and rising interest rates.

This has hindered UK plc’s profitability. The data reflects challenges associated with stubborn inflation, weakened consumer spending, and a choppy and uncertain business investment environment.

Leisure & Hospitality has remained the most ‘at risk’ industry, with 22.3% of businesses in this industry ‘at risk’. This is an adverse movement of 1.9 percentage points from the previous tracker. High inflation, labour shortages and diminished discretionary spend due to consumer confidence challenges and increased strain on household budgets continue to bite the sector. The industry as a whole still has a long road to recovery with many companies in the hospitality industry only slightly exceeding their 2019 sales levels in 2022. This is in absolute terms, meaning in real terms any growth would be cannibalised by inflation. This is indicative that the sector is still yet to revert to pre-Covid performance.

Health & Social Work Activities, previously ranked 10th, has seen a sharp increase in ‘at risk’ businesses of 6.2%. This has caused the industry to become the 2nd most ‘at risk’ in the current tracker with 17.9% of businesses deemed to be ‘at risk’, previously 11.7%. The challenges faced include increased staff costs due to staff shortages and reliance on temporary as well as the increase in the National Living Wage. The increased cost of recruitment, training, and agency fees have also placed a strain on already stretched budgets. The sector faced a lack of resources to meet growing demands, leading to service backlogs, staff burnout, and ultimately, a strain on the quality of care provided. The government has implemented various initiatives to address these challenges, including increased funding and workforce development strategies. However, the long-term financial sustainability of the sector remains a critical concern.

Utilities had the lowest percentage of ‘at risk’ businesses down to 4.7% from 8.3% previously. This is unsurprising as this sector has consistently ranked in the lowest three industries ‘at risk’ in previous iterations of this article, likely as Utilities businesses tend to resist economic volatility. Unlike other sectors, such as consumer discretionary industries, demand for utilities tends to be stable irrespective of how the economy is performing. Energy producers have benefitted from increased prices, mostly related to reduced supply given the Ukraine / Russia conflict.

Excluding the industries already discussed above, the two biggest risers were Water & Waste (increasing 6.7 percentage points to 14.3%) and Retail & Wholesale (Increasing 1.9 percentage points to 9.1%).

Water & Waste businesses have been impacted by rising energy prices as they require significant energy for water treatment and pumping. General inflation has also pushed up costs for materials, equipment, and labour, further squeezing profit margins. The water regulator, Ofwat, has taken stricter enforcement actions against companies with poor performance on environmental issues and customer service. This resulted in fines and customer rebates, impacting their bottom line.

Retail & Wholesale had initially bounced back slightly post covid, but now appears to be on a downward trajectory in terms of the number of ‘at risk’ businesses. They have faced a challenging environment of rising input costs, including transportation and utilities, which they cannot fully pass on to consumers due to inflation-sensitive spending. Global supply chain disruptions have also impacted the sector, leading to stock shortages and higher prices, further challenging businesses. What we are now starting to see bite is, where consumers have become more cautious with their spending, due to economic uncertainty and rising costs, this is significantly impacting the demand for non-essential goods.

We have also analysed the businesses previously identified as ‘at risk’ but that have dropped out of our analysis.

Of these ~300 businesses, a fifth are no longer active, being either dormant, dissolved, in administration, liquidated or inactive.

A further 25% are showing greater signs of distress, either not having filed accounts since 2020, or having experienced a significant decline in turnover and now having fallen below our 10m lower ‘mid-market’ threshold.

What regions are most ‘at risk’?

Our graphic below looks at the proportion of ‘at risk’ businesses within each UK geographic region using registered office information.

Geographically, the concentration of ‘at risk’ businesses is fairly consistent across the UK. Of the twelve regions, eight have an ‘at risk’ percentage between 12% and 15%, three have an ‘at risk’ percentage between 11% and 12% and Northern Ireland was an outlier with an ‘at risk’ percentage of on 7.2%, albeit from a small sample size.

West Midlands, South East and Greater London were the three highest ‘at risk’ regions

West Midlands has the highest concentration of ‘at risk’ businesses with 14.4%, previously 11.6% in May 2023. Across 10 of the 14 industries, the region has an above national-average percentage of ‘at risk’ businesses.

The region also has a high proportion of Manufacturing businesses which is pushing up the average. 17.3% of Manufacturing businesses in this region are deemed to be ‘at risk’ compared to the national average of 13.4%.

Health & Social Work Activities and Water & Waste were also much higher than the national average (by ~7.6 percentage points) with ‘at risk’ percentages of 19.2% and 15.4% respectively.

The West Midlands has seen a decline in its share of UK exports in recent periods. This could be attributed to various factors, including challenges faced by its dominant industries in global markets and Brexit's trade barriers and new customs procedures increasing costs and complexities. The region faces specific challenges related to its industry composition and slower post-pandemic recovery in certain sectors, coupled with broader national economic pressures. However, positive developments such as foreign investment increases, albeit anecdotally, offer some hope for future improvement.

The South East had the second highest percentage of ‘at risk’ businesses at 13.4%, previously 12.3%. The South East’s ‘at risk’ percentages were above average in most industries. Agriculture, Forestry and Fishing, was 5.5% higher than average in the South East with 22.7% of businesses in this industry and region deemed to be ‘at risk’. Mining and Quarrying and Transport and Storage were both significantly higher than the national average, scoring 25% and 20.7% respectively. Mining and Quarrying does have a limited sample size in this region which may skew the data slightly. Interesting Leisure & Hospitality, the most ‘at risk’ industry, had a lower ‘at risk’ percentage in the South East with only 12.7% of businesses deemed to be ‘at risk’ versus the national average of 20.4%.

A sharp rise was observed in the number of profit warnings issued by companies listed in the South East, according to other market commentators. This is reflective of South East ranking high in the latest ‘at risk’ tracker. Likely issues impacting businesses in this region include increased costs and supply chain issues, however if consumer demand and confidence declines, it is likely that other underlying pressures will be revealed.

Greater London was third with an ‘at risk’ percentage of 13.3%. Greater London data is likely skewed slightly by businesses having their registered office in the region but core operations spread across the UK.

The challenges faced in the Capital stem from a higher-than-average 'at risk' rate among businesses in several industries including Health & Social Work Activities, Real Estate, Construction and Leisure & Hospitality. Slow employee return rates, increased employment costs and fierce competition within these sectors in London are cited as potential causes by businesses. Health & Social Work Activities appear to be significantly more ‘at risk’ in the Greater London with an ‘at risk’ percentage of 25.5%, 11.7% above the national average. Real Estate Activities fall into the same category scoring 21.2%, 6.2% higher than average. Leisure & Hospitality and Construction were both ~3.5% higher than the national average in Greater London, with 23.8% and 14.2% of businesses deemed to be ‘at risk’ respectively.

Two competing dynamics are the London-area’s reliance on Financial Services and Professional / Business Services. The latter, representing a roughly a third of all businesses in London’s mid-market, has an ‘at risk’ score of 12.8%, 0.6 percentage points higher than the national average. Conversely Financial Services businesses in the Capital are less likely to be ‘at risk’ with a percentage of 9.3% versus a national average of 10.6%.

Business turnaround: what do at risk firms need to do?

Whilst our analysis shows the number of firms ‘at risk’ may be lower than expected, there is still a significant minority that may not be well-positioned to enter choppy waters. Companies that are currently at risk with low profitability and high debt burdens need to address their resilience and take action.

The strength of company balance sheets often depends on the level of funds shareholders have taken out as dividends, the amount of debt taken, or the amount invested in new products and assets. This will impact a company’s options and the time available to implement changes or turnaround actions.

It is likely that most ‘at risk’ businesses will have reluctantly moved further to the right on the corporate decline curve as a result of recent economic challenges – see chart below.

In general, businesses responded well to the impact of geopolitical tension, Covid-19 and Brexit. They focused on minimising the effects on business operations by reducing costs, preserving cash, seeking additional funds to plug short-term funding gaps and implementing necessary health and safety measures to ensure employee safety.

However, most businesses will require more transformational action to ensure they can prime themselves to survive the coming economic turbulence. We highlight below some of the short-term actions that we have advised clients to implement. Addressing these issues now has been fundamental to a business’ longer-term health and protecting shareholder value.

The restructuring provisions within the recently introduced Corporate Insolvency and Governance Act 2020 (‘CIGA’) are a welcome addition to already available restructuring tools, especially as these are debtor-led, allowing the company to control the restructuring process. These new tools grant businesses a level of moratorium protection as they navigate their way out of the current environment. However, the use of these protections requires early intervention to allow time to create a viable financial and operational restructuring plan.

Although the current economic environment is having a significant impact on the mid-market, we would suggest that companies should respond positively to the challenges and use instability as a catalyst for change, and an opportunity to build resilience into their operations. Many of our clients have already embarked on this journey and are actively in the process of reshaping their businesses.