Zombies in our Midst: Are Undead Companies a Threat to Your Community?

Earlier this month, at #IEDCAnnual, in the YP Session, we talked about problems cities will face in the next decade that don't fall within the typical categories and buzzwords bandied about during most economic development conversations. I mentioned that one of the most overlooked threats facing our cities is the potential for a zombie business apocalypse. A zombie business is defined as a company whose cash flow is insufficient to pay the interest on their debt.

The IMF has recently rung alarm bells stating that the global economy is facing a $19 Trillion debt time bomb. IMF officials explain that extremely low interest rates have enticed many corporations to take on as much debt as their cash flows can possibly service, with many of those borrowed dollars then going into share buybacks, among other things. As a result, cash flow to service this debt is starting to get tight, meaning that corporate balance sheets are becoming increasingly fragile, thus opening the door to some nasty outcomes if there is a negative shock, either to their company, specifically, or to the broader economy.

The chart below shows current US corporate debt as a percentage of GDP. It is reaching all time highs.

Tobias Adrian and Fabio Natalucci, both senior officials at IMF who oversee the Global Financial Stability Report (GFSR) recently put it this way,

“We look at the potential impact of a material economic slowdown – one that is half as severe as the global financial crisis of 2007-08. Our conclusion is sobering: debt owed by firms unable to cover interest expenses with earnings, which we call corporate debt at risk, could rise to $19tn. That is almost 40% of total corporate debt in the economies we studied.”

Now, these economies that they studied are the eight largest economies in the world, namely, the US, China, Japan, Germany, Britain, France, Italy and Spain. So what they are warning us is that in each of these economies, we are facing a major debt crisis. In other words, possibly as many as 4 in 10 corporations will fit the definition of a zombie business if we have a recession even half as bad as the one in 2008. Hence, we may be on the verge of a true zombie apocalypse of the corporate variety.

This sounds paralyzing. In the wake of such large scale forces, it can be tempting to just throw up our hands and feel powerless. And, while I don't pretend that this brewing crisis can be remedied just by local and state entities addressing it on their own, I also refuse to think that we should just sit back and wait for the tsunami to hit. It will certainly take Federal Government and Central Bank intervention if such a crisis were to erupt. However, that does not mean that we should not do what we can to get prepared. As such, for economic development professionals, I pose the question: How should cities, states and economic development professionals prepare for this zombie apocalypse? Here are a few thoughts I've been thinking about. I am interested in hearing your thoughts, as well.

1. Zombie companies still have a number of assets. Is there a way to link those assets to younger, more entrepreneurial companies with greater growth potential (or to more entrepreneurial employees within these companies) so that we can leverage them into future economic growth? Many times these assets are in the form of talent. Can this talent be harnessed into new ventures? How do entrepreneurs and start-up companies gain access to the existing, long-standing businesses in your community? What can cities and states do to foster working relationships between these businesses? More broadly, what role do economic developers play in helping to promote creative destruction in our local economies? Sometimes, what our businesses need most is a refresh in their thinking. It is not for us to tell them how to think, but we can promote that refresh by creating the atmosphere and the opportunities for companies of all sizes to interact and share ideas?

2. Many communities have a plethora of smaller, sole proprietor manufacturing businesses. And in several parts of the country, owners of these businesses are closing shop, not because they lack viable businesses, but because they have been unable to identify a successor to take over and buy the business from them. To prevent from losing these businesses and their corresponding jobs, cities should consider starting a manufacturing growth strategy that entails training up workers and others to take over management functions of these businesses. Co-ops and other investor pools can also be created to work through the transition of ownership. Furthermore, several of these companies could benefit substantially from refreshing their business strategy, with a renewed focus on business development functions. My friends at St. Louis Makes are doing just this, and are a great example to follow.

3. Identify who is most at risk, and get ahead of the curve. Business retention and expansion visits are a tried and true staple of economic development programs everywhere. What is your relationship like with your most important businesses? We cannot expect that our business friends are going to divulge sensitive financial information to us, but if they are publicly traded, their financial information is available to you, and you should be familiar with them. What does their profit margin look like? How about their ageing accounts receivables, their current and quick ratios, and their Free Cash Flow to debt ratio like? And, how has their long term debt been changing relative to their income? With private companies this information will most likely be unavailable to you, but through conversational questions with business owners and managers, you may be able to uncover some of this information with them, as well. But remember, this is sensitive information. If an NDA is not signed before getting this type of information from a business, you should act as if you have one, anyway. The last thing you want is to lose the trust of your business community. If you do find a company at risk, that is the time to pull together your response team to figure out what can be done, whether it be some type of restructuring including government loans, to bringing in the state to help in some way. If your community has a best practice that you do when you identify companies at risk, please share in the comments.

There are many potential strategies that can be pursued to help prepare your businesses and your community for the zombie apocalypse. I have only touched on three, but you should also consider workforce and community level preparedness measures that you can take, as well. My hope in writing this is to expand awareness and begin a discussion of the risks that currently face our companies and our communities as well as the practices we can take to help mitigate them. Together, we can think through how to address a potential zombie company apocalypse, before it happens.