Investing in a zombie company

The Financial Times recently reported that the UK Future Fund, a government-run venture fund set up during the pandemic, has mostly invested in zombie businesses that have no long-term viability.  This is not surprising given the apparent confusion over whether the fund was focused on growth or simply providing a backstop for high-risk businesses.

The minutes from an audit committee meeting, that have recently come out, said that the £1.1 billion portfolio made up of 1,190 early-stage companies had a significant tail of dormant companies.  This should concern UK taxpayers that funded the scheme, but what should concern taxpayers even more is that this statement could also be applied to the whole UK economy.

For the last decade barely profitable businesses have been propped up by ultra-low interest rates.  In the last 12 years, after the Great Recession, there was a net increase of 2.3 million companies in the UK according to the data from Companies House.  In the 12 years before, the net increase was 1.5 million.  New company formation may sound like a good thing, but if uncompetitive businesses are not dropping out as new innovative ones form the market becomes crowded and resources are wasted.

Creative destruction, a phrase coined by economist Joseph Schumpeter in 1942 is the process by which companies are consistently replaced by more efficient ones.  This process is essential for an innovative economy and was put on ice during the pandemic.  In the 15 months before the first lockdown there were 21,287 company insolvencies in the UK.  In the 15 months after there were 14,146, 34% lower and probably helped by the furlough scheme.

Aided by rising interest rates and energy costs, the creative destruction process is now working hard to make up for lost time.  In the second quarter of 2022 there were 5,629 registered company insolvencies, up 81% from the same period last year, the highest quarter level since 1960.  Listed corporate restructuring firm, Begbies Traynor, said that 200,000 businesses failed to meet the repayment terms for the Bounce Back Loan Scheme (BBLS) in its recent red-flag report.

Headlines of rising liquidations might be adding to the general sense of anxiety we are feeling.  However, in the long term new and more productive businesses that pay higher salaries will take their place and that is good news for everyone.  However, in the short-term the current self-made crisis means that the number of businesses that are likely to fail will rise significantly, and that means that many people will feel the pinch even more in these uncertain times.