What are zombie businesses and why must SMEs avoid them?

Zombie businesses. Not a niche section of the retail market providing horror fans with access to the zombie costume of their dreams, but a term used to describe any company so debt laden it can only afford to pay interest on its loans. 

For these businesses, the loan principal remains untouched once other fixed costs are paid, leaving a stagnate pile of debt and no cash for growth or supplier repayments.

Zombie businesses can however, afford to keep the lights on — neither dead or alive, existing right in the area between a functioning business and an insolvent one.

The term itself has been around since the Japanese economic collapse of the 1980s, which saw banks prop up many large corporations that would have otherwise failed. In 2022, the term has made a popular return with the average number of local companies entering administration each month almost halving throughout the pandemic from 700-800 to 350. 

Struggling Aussie businesses were supported in 2020 and 2021 by safe harbour insolvency protections and COVID-19 emergency measures such as JobKeeper, bank loan holidays and greater leniency from the Australian Taxation Office and the Australian Securities and Investments Commission. With most of these safeguards now coming to an end and major banks returning to their normal working rhythm, local administrations are expected to rise, taking the aptly named zombie business with it. 

The rise of the pandemic-induced zombie business

Unlike their pop-culture counterparts, Zombie companies generally appear normal to outside parties, making it difficult for even the companies they trade with to identify them. With no regulatory body reporting on zombie businesses, it’s practically impossible to identify and keep track of them. 

Throughout the pandemic, zombie businesses were able to fly under the radar resulting in low levels of external administration. But as the nation weathers the COVID-19 storm and safe harbour provisions are steadily removed, the risk of falling victim to a real-life zombie is steadily decreasing. 

Without these safeguards in place, companies can no longer trade as insolvent, decreasing the cascading effect of one zombie business’ closure on its trading partners.  

But that’s not to say these companies are going away — far from it!

How SMEs can avoid falling victim to the zombie apocalypse 

One way to catch a zombie before it’s too late is to keep a close eye on ATO tax defaults on credit reports. This is a near certain sign of a company heading towards administration, and one which could wreak havoc on its trading partners operating under the impression of business as usual. 

While fears of a business failure avalanche appear to have subsided in early 2022, CreditorWatch data shows industry repayment times in high volume SME sectors including food and beverage services, arts and recreation, and education and training registered the highest probability of default in the next 12 months. 

To remain successful and profitable, businesses must remain vigilant when scrutinising their suppliers’ ability to pay. It can be difficult and uncomfortable to raise questions about extended payment times or increasing debt, especially when it involves a long standing business relationship. 

However, the risk of falling victim to a zombie business that’s run out of life support should be enough to encourage every business owner to reassess payment terms with a supplier exhibiting zombie-like symptoms.