What Does Zombie Firm Mean?
A zombie firm, in the private equity context, refers to PE firms that cannot raise additional capital to improve existing investments in order to monetize them.
Zombie firms typically still own some companies in their portfolio that cannot be optimized nor grown unless additional capital is invested in them. Because these firms may have delivered unacceptable returns with past investments, the limited partners are unwilling to commit additional capital to help these average portfolio companies achieve a liquidity event. Ultimately, the companies will get liquidated at a lower return or a possible loss, further intensifying the inability of zombies to secure future capital commitments from LPs.
Divestopedia Explains Zombie Firm
The "zombie" moniker is a reference to the undead state in which zombie firms exist. They are not dead from a legal standpoint, but might as well be, given that they cannot raise additional capital. Competition for capital among private equity firms goes through cycles and, at a certain point, not everybody is going to get funded. Furthermore, limited partners continue to demand better returns and less risk of their general partners. This push toward higher accountability from general partners is weeding out the best from the rest, with the ultimate result being an increase in zombie firms that eventually will disappear.
The concept is important to a business owner because it adds another level of diligence required from the portfolio company's perspective. Not only do you need to get along with a PE firm that you choose to do a deal with, but it also can help to be aware of their past performance. It's not a good situation if your investor is a zombie as it will hurt your chances of expanding, shrinking your time horizon, and could possibly result in you being pressured to sell as a distressed situation.