Zombie companies

Australia’s COVID-19 induced economic recession has put many businesses under financial pressure. But unusually, the number of Australian businesses that have had to close down due to running out of money (become insolvent), has actually fallen in 2020.

This is partly due to economic stimulus measures that have been supporting businesses financially (e.g. the JobKeeper Scheme), but is also happening because a range of temporary changes to regulations have enabled many businesses to continue to operate when they might otherwise have been forced to close.

The aim of the temporary changes to insolvency regulations has been to allow business more time to get on top of their debts as lockdown restrictions ease. The measures are due to run out at the end of 2020. While these changes may give some businesses the time they need to improve their financial position and stay afloat into 2021, there is concern they may also be delaying an inevitable wave of insolvencies for businesses that would have failed, many of them even in the absence of COVID.

Chart 1 below shows that despite being in the middle of a severe recession, the number of companies in Australia entering external administration due to insolvency over the June and September quarters (when the main impacts of COVID-19 have taken place), is lower in 2020 than it has been in two decades.

Chart 1: Number of companies entering external administration in the June and September quarters of each year

Source: ASIC 2020, Insolvency statistics Series 1

The data suggests that if 2020 had been similar to the previous two years, then an additional 800 businesses (on top of the existing 2,880) would likely have entered external administration by now, and a further 1,400 would do so before the end of the year.

Unfortunately though, 2020 is far from being similar to recent years, so the expected backlog of businesses that may fall under once temporary relief measures and changes to insolvency rules are lifted could be much larger than that estimated above. 

While we don’t know how many companies may face collapse in 2021, we can get an indication of the scale from ABS data that reveals 31% of all Australian companies were still facing monthly revenue falls in October. While this is much fewer than the 70-80% of businesses that saw revenue tumble back during the height of COVID-19 in Australia, it does show that there is a substantial proportion of businesses that are continuing to fall behind even as the economy opens up.

On the composition of businesses that are still struggling, the majority are small businesses (sole traders through to companies with up to 19 employees). There are also higher than average shares of businesses that continue to lose revenue in the construction, arts and recreation, and administration sectors. 

Fortunately, some additional support is on the way. The Federal government delivered a gangbuster budget deficit equivalent to 11% of GDP, and the RBA is giving guidance that official interest rates will stay at zero for three years. Most state and territory governments are in the midst of rolling out additional support measures in their respective budgets. The Federal government has also announced that permanent reforms to insolvency regulations for small businesses will be put in place from the start of 2021, which may provide some additional support to small businesses once current temporary measures are removed.