The anatomy of a zombie company and why they persist

PE funds tend to be constrained by a realisation timeline, a looming deadline by which investments in the fund need to be turned to cash, and waiting around for the undead to resuscitate is often not a luxury available to a PE firm. This is the case even for on balance sheet portfolios, which might not have a definitive fund timeline to deal with, but which will still have an anxious investment committee watching.

Several factors are therefore contributing to the otherwise puzzling persistence of these companies that resemble the undead:

• Avoiding realised losses: For PE firms, publicly acknowledging a failed investment through liquidation or a deep restructuring can mean realising significant losses, impacting their fund’s overall performance metrics and making it harder to raise future funds. There is a strong incentive to ‘kick the can down the road’ in the hope of a miraculous turnaround (read: a heartbeat) or a more favourable market environment.
• Reputational concerns: Similarly, liquidating a business carries a strong negative stigma and can greatly damage the PE firm’s reputation – the market perceptions become a toxic mix of a poor initial investment decision, a failure to support its portfolio companies, and a failure to manage its investments. It is easier to keep the corpse politely seated at the board table than to host a funeral that invites post-mortems.
• Lack of liquidity: In stressed markets, which South Africa is, auctions can feel like haunted house tours – plenty of shrieks and few committed buyers. A failed sale process is its own horror story, carrying nearly as much of a stigma as a liquidation for PE firms and, because the failure becomes known, makes the asset even harder to sell. PE firms would prefer to hold on to the cursed asset, waiting for an improvement in market conditions.
• Complex capital structures: Many PE deals involve significant leverage. Unwinding these complex debt and equity structures is time-consuming and expensive, and may trigger tax or covenants that are difficult to manage, especially if the company is already underperforming. This is can be very damaging for the PE firm’s important relationships with lenders.

Continuation funds (generally, a later fund managed by the same PE firm but with a different investor mix) might acquire a zombie company to buy some more time, but it is a very complicated process for both funds to get a fair deal, and does not deal with the underlying issue. A fire sale or liquidation would at least get rid of the zombie company, but would realise a loss (and no-one buys a business to lose money).

The economic drag of the undead

The proliferation of zombie companies, whether owned by PE or otherwise, has detrimental effects on the wider economy because zombie companies tie up capital, labour, and other resources that could be more efficiently deployed by healthier, innovative businesses. This stifles productivity, growth, and overall economic dynamism. By simply existing, zombie companies can depress market prices and investments, making it harder for healthier competitors to thrive and discouraging new market entrants. This creates a negative reinforcement spiral, leading to a less competitive landscape and reduced innovation.

In addition, while individual zombie companies may seem small, their collective debt burden can pose a risk to the financial system, especially during economic downturns when defaults become more widespread.

Escape from Zombieland

Within this context, there is a strong incentive to find ways to revive a zombie company. PE firms, and indeed the broader financial ecosystem, can (and sometimes do) employ several strategies, including:

• Embarking on an aggressive operational restructuring, including cost optimisation by addressing operational inefficiencies, supply chain optimisation, and overhead reduction. This might also involve shedding non-core assets or divisions.
• Supplementing management teams with experienced turnaround specialists who have a proven track record can be a game-changer.
• Negotiating with lenders for more favourable terms, such as lower interest rates, extended repayment periods, or even debt-to-equity swaps, can alleviate immediate financial pressure.
• A strategic realignment and market focus can have a Lazarus effect, as can a strategic divestment of underperforming or non-strategic assets.

Nampak stands out as an example of the success these approaches can achieve. It faced severe financial distress due to high debt levels, poor operational performance, and exposure to volatile African markets. Its financials were dire enough to qualify it as a ‘zombie company’ – surviving mainly on debt without generating sufficient returns. Nampak undertook a successful informal restructuring, during which it appointed a chief restructuring officer to lead its turnaround, sold non-core assets to raise capital and reduce debt, renegotiated debt terms with lenders, streamlined operations, and exited underperforming markets.

With examples like these in mind to solve the zombie company problem, we would advocate for PE investors to consider, as a realistic option, a more radical (but calculated) approach: a formal (statutory) pre-packaged restructuring through business rescue or a formal compromise in terms of section 155 of the Companies Act 71 of 2008. While often considered a last resort, a pre-packaged restructuring can allow a company to shed onerous debts and contracts, streamline operations, and emerge as a healthier entity, with the backing of the existing PE firm or new investors, or a combination of these. This allows for a controlled restructuring rather than a chaotic process.

What does it entail? A change in perspective, because it requires a debtor company and majority creditors to negotiate and agree on the plan (or proposal) before initiating the formal process, rather than during the process. A pre-packaged restructuring is faster and less disruptive than a formal process (as it is designed to end as soon as it begins), and as a result, reputational harm is cauterised and business continuity is preserved.

In summary

PE firms pride themselves on being decisive in making investment decisions and on being nimble in taking advantage of the market. They are unafraid of aggressive structuring and a robust negotiating approach. This contrasts with the deferral of decision making, which often arises in relation to zombie businesses.

Addressing this issue may simply require a shift in mindset, a willingness to confront difficult realities, and a proactive approach to restructuring, rather than letting the zombie company wander mindlessly on. The dead may sometimes walk, but the living can always do something about it.