By Geoff Bouchier, Partner at Duff & Phelps

We are beginning to see the dawn of a new era in corporate finance for the mid-market. With the banks unable or unlikely to lend, businesses need to look to Alternative Capital Providers (ACPs) — private equity, fund managers, the bond markets and other non-bank lenders. This is a trend already underway and one set to transform the sector.

For too long the focus has been on the issue of “zombie companies” and how they are holding back economic recovery. But according to Bouchier, rather than killing them off, what is really needed is some “tough love” and a new way of thinking when it comes to corporate finance.

The argument has been that zombie companies are draining capital out of the economy that could otherwise be used to fund startups or expand successful businesses. We often hear that with bank resources focused on the zombies, they are limited on pursuing new lending and other investment.

A zombie company is one that has been defined as near the point of insolvency but just able to survive — neither failing nor thriving - only able to pay the interest on its debts but not tackle payments around the debt itself.

According to statistics released by R3: The Association of Business Recovery Professionals in November 2012 there are some 160,000 "zombie businesses" teetering on the edge of solvency. This is up 10 percent on the five months previous from 146,000. As well as only being able to pay the interest on debts, R3 itself also identifies three further defining features of a zombie company: having to negotiate payment terms with suppliers; struggling to pay debts; and, facing the probability that if interest rates rise, they will be unable to service debts at all.

We really do need to look at this in another way. We are talking about 160,000 companies employing more than a million people. There would be further damage done to the economy if the support to these companies was cut off and they were to fail. What we would argue is that these companies now need more than ever, an injection of new money, skills and support.

These companies are making little or no profit. But rather than pull the plug on these businesses, they should be supported financially. Should financial stakeholders no longer support zombies companies, it will not make banks suddenly begin lending to start-ups. In fact, it could be argued that the opposite would be true — once burned, twice shy is the old saying.

What is needed now is a fresh look at financing, as the traditional routes to credit have become constrained. We need to stop thinking that the banks are the only source of funding.

There will be some of these companies that are simply not capable of surviving and will need to be wound up. However some are viable and they in turn need investment to review their operational structure rigorously and not be afraid of change to move forward. So instead of looking at these companies as the ‘Living Dead’ perhaps what we need to do is rethink our attitude towards them and give them some tough love instead.

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