Small Talk: Sorry, but it's time to end the misery of these zombie firms

Here's the thing about zombies. As every horror movie fan knows, the fact the undead are invariably victims themselves – typically of some awful pandemic – they still pose a threat that must be countered.

So it is with zombie companies, small and medium enterprises whose financial circumstances have left them in limbo. Their revenues are sufficient to service the interest on their debts, which has been keeping the banks off their backs, but there is little left over once other costs have been met. The capital value of their debt is not diminishing and they have no funds with which to make the sort of investments that might produce the future growth needed to get them out of the trap.

The most recent figures from R3, the insolvency industry trade body, put the number of zombie companies at 160,000, or one in 10 British businesses. The total has risen by about 10 per cent in each quarter of this year and there is no reason to expect the zombie plague to ease in 2013. SMEs' costs are rising while their revenues in a zero-growth economy are not.

We should all feel sorry for these businesses. Having been encouraged to borrow to grow – both by banks and by a sustained period of economic growth prior to the financial crisis – they now find themselves unable to repay what they owe.

Our sympathy, however, should not obscure some hard truths. These SMEs are unable to contribute to economic recovery, and may well be a drag on it. Many are staying afloat only because interest rates are low, but in doing so they're taking market share from more healthy businesses that might otherwise have a chance of a more robust future. That stifles job creation, competitiveness and growth. The zombies are pulling the economy down.

What is to be done about these businesses? One answer is that SMEs that are not complete basket cases need to be encouraged to do more to break out of the cycle. There are actions struggling SMEs can take to achieve a firmer footing. These include closer attention to costs, but also a focus on cash flow – through better debt recovery or invoice financing, for example.

The banks have a role to play with these companies too. While lenders are rightly reluctant to throw good money after bad, they must do more to support SMEs that are being held back by lack of finance. The easiest and most rewarding way for any business to get on top of its debts is to generate additional revenues – those that might be able to do so with the help of extra credit should not be denied access.

There will, however, be a large number of zombie businesses that cannot be restored to health, and we are reaching the moment where we must kill many of them off The only reason many zombie companies are still trading is that the banks have treated them benignly.

This forbearance cannot go on for ever. The worst of the zombies must be put out of their misery for their own sake, for the sake of their competitors and for the sake of the economy.

Small-company stocks have been in doldrums, but 2013 may be brighter

Stock markets do not always follow the rules. Conventional wisdom has it that smaller companies tend to outperform as economies come out of recession – they are able to capitalise on green shoots more quickly than their larger brethren and are generally less exposed to the added complexities of international exposure.

We have not seen that during 2012. The FTSE 100 Index of the very largest companies is up by about 7 per cent over the year, slightly ahead of the All-Share, which includes smaller companies. But the Alternative Investment Market, the junior exchange is down by about 0.5 per cent over the year.

Why have smaller companies failed to make more substantial gains? One answer is that the economic recovery has failed to take hold. While the UK has exited recession, growth remains anaemic and many companies fear they face a triple dip.

Another explanation lies in simple arithmetic. The uncertainties of the mid-year, when the eurozone crisis threatened to engulf the global economy, sent smaller company valuations into a tailspin. Their second-half performance has been much stronger than that of larger companies, but they came from a long way behind.

So what of 2013? Institutional investors are relatively bullish about the prospects for smaller companies. "With the market as a whole trading on a significant discount to long-term averages, particularly in the small and mega cap sectors, I find myself generally positive about the prospects for equities in 2013," says Alex Wright, manager of Fidelity UK Smaller Companies Fund and Fidelity Special Values.

"Conditions are perfect for M&A activity, with record low interest rates, strong corporate balance sheets in large-caps, bargain valuations in small-caps, and the economic environment rewarding those organisations that can operate at maximum scale and efficiency."

Stock-picking, however, will be crucial. UK smaller company funds, with professionally selected portfolios, have been the top performers in the collective investment business during 2012, gaining 20 per cent or more.

Small Businesswoman of the Week: Helen Keenan, founder, Little Punk London

I'd always thought I'd have a big idea and start my own business, but I ended up working in the public sector. Then last year I decided to become a stay-at-home mum, and I suddenly had time to think about what I might do.

The idea for Little Punk London came from my experience with my three-year-old daughter, who hates getting dressed in the morning. She loves stickers and it occurred to me that this might be the way to make it much easier to get her into their clothes. We make well-designed and ethically produced T-shirts with stick-on designs that children can choose and adapt each day themselves.

The hardest thing about getting the business going was finding a producer in the UK who was prepared to manufacture on a small scale to begin with. I encountered so much negativity before finding someone.

We did talk to some Chinese manufacturers too – they're not much cheaper but they were much more prepared to do what it took to get the business.

Business is going well and we're investigating the business angel community because I need to try to scale this up in the UK and move into international markets. This time next year, I want to have launched in the US too.

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