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Alix McCabe: There are companies that exist in a sort of limbo. They're not quite bankrupt, but they aren't really making money either. They shamble along in a state of undeath, and if your business happens to make a deal with them, they could drag you down too, and that means they definitely deserve a place on...


Audience: Wheel of Risk.


Alix McCabe: Welcome to Wheel of Risk, proudly presented by Allianz Trade. I'm your host, Alex McCabe. On every episode, we spin the wheel, land on a new worry, and then tackle it head on by bringing you expert insights and advice to help you keep your business solvent, secure, and well ahead of the competition. Today I'm excited to introduce you to a new voice. Allen Gebarowski is a regional vice president, Northwest Region, at Allianz Trade, based in beautiful Portland, Oregon. Allen, welcome to Wheel of Risk.


Allen Gebarowski: Thanks, Alix. Pleasure to be here. I'm excited.


Alix McCabe: We're glad to have you. So, all right, why don't you go ahead and give that wheel a spin?


Allen Gebarowski: Okay. I'm going to spin the wheel. Let's go.


Alix McCabe: Oh, the perfect topic. Just ahead of Halloween. You've landed on dawn of the debt, a look at the risk of zombie firms.


Allen Gebarowski: Yep. That is a good topic for the current environment, I would say.


Alix McCabe: Prepare to face your fears and let's go. The trouble with zombie firms, much like any zombie, is that they tend to lurk and catch their victims off guard. But in the case of businesses, it doesn't take a bite to get infected. All it takes is a handshake or signing on the dotted line. To elaborate a little bit more on the nature of these businesses, here's our old friend, Dan North, senior economist for North America at Allianz Trade.


Dan North: There is no formal definition of a zombie firm, but in principle, zombies can't service debt. They can only pay the interest on the debt, and therefore they have to constantly tap banks or financial markets for capital. Another way of putting it is, the company's not generating enough cash to cover its basic expenses, let alone turn a profit.

Zombies often arrive from trying to expand too fast. A successful company may have great plans for a new product, borrow a lot of money to finance it, and then it fails to live up to expectations. So there may be plenty of companies, zombie companies, that are going to need to refinance now at substantially higher interest rates that may not be able to, and that's the big risk that you'd be facing.


Alix McCabe: A big risk indeed. We'll hear from Dan again a little bit later on, but I'm curious, Allen, Dan said there may be plenty of zombie companies out there. Do we know how common they are?


Allen Gebarowski: Well, it's really hard to know for sure, and that's the danger. Most people really aren't looking into tracking it. We really only have insight to publicly traded companies because we have access to their financials. There's way more privately held corporations in the United States than there are publicly traded corporations. So how many of those are teetering on the edge of becoming a " zombie firm?" We have really no idea, but what we have seen is a huge increase in bankruptcies year over year.

Looking back the last couple of years post COVID, bankruptcies have been nil. They've been really down. I haven't seen a ton of trends there, but this year alone, there's huge increases in bankruptcies. Yellow, one of the largest freight brokers and freight companies in the country, just filed for bankruptcy. We saw, I think, Bed Bath & Beyond, Rite Aid just filed for bankruptcy. So there's huge bankruptcies falling left and right this year.

In addition to that, we're seeing a huge increase in slow pays reported by our policy holders, which is something we rely on to navigate some of the credit risk for the customers that we are working with. Day sales outstanding are increasing, people are taking longer to pay, and due to the interest rates and some of the things that are happening in the economy, working capital seems like it's more expensive and it's harder to come by, which could be an indicator why people are taking longer to pay right now. So claims are up, slow pays are up, and bankruptcies are way up.


Alix McCabe: Why aren't these zombie firms on the radar for most businesses, would you say?


Allen Gebarowski: Well, most businesses don't know they have an issue until there is one, essentially. At least in my experience, most of our clients that we work with, before they got into a relationship with us, partnership, really reliant on payment history and the relationships with their customers. So they're not really doing a lot of due diligence to spot all the warning signs, quarterly checks on financials, credit audits, things like that. They figure if it ain't broke, why fix it?


Alix McCabe: Yeah. I get that. Why do you think people aren't always digging as deep as they need to when starting a new business relationship?


Allen Gebarowski: There could be a number of reasons, but a lot of it comes down to time, misplaced trust. Some people might get offended if you ask them to see their financials or look into their books.


Alix McCabe: I have nothing to hide. What do you mean?


Allen Gebarowski: Yeah, exactly. They don't want to rock the boat, so they figure, hey, if I'm getting paid, everything's fine. I'll just leave it as is.


Alix McCabe: So then, building on that, what are some of the red flags that business leaders should be looking for to ensure that they don't get infected, so to speak?


Allen Gebarowski: Well, one of the main things that you could really look at to predict if there's going to be trouble on the horizon are changes in payment terms. So, are one or multiple clients of yours asking to increase their terms of sale? Maybe they're on a net 15 terms of sale and they want to go to net 60, net 90, so they need longer to pay. A lot of cases, they might just be slow paying in general. You give them net 30 terms, their DSO's net 45, net 60, net 90. There's a bunch of different reasons and warning signs you could see on the horizon. But if you're not paying attention, that could happen really quickly, and before you know it, you're in over your head.


Alix McCabe: At the start of this episode, we heard from Allianz Trade's Senior Economist for North America, Dan North, and he touched on what you're talking about a little bit here, the risk of doing business with zombie firms. But I'd like to bring Dan back now to unearth, if you will, a bit more detail for us.


Dan North: Simply put, zombie companies are much more likely to default than non zombies. Zombie companies are just skating around the edge of bankruptcy, and they often have more debt than equity, and again, they can only pay interest, and they're going to pay the banks first or other creditors like that, so that they continue to refinance. Trade creditors are the last ones to get paid. So if those companies, those zombies, don't make enough to more than pay the interest payments from banks, for instance, trade creditors are going to take a hit. That's the real risk with trading with zombies.


Alix McCabe: Allen, any reaction there to what Dan shared?


Allen Gebarowski: Dan is absolutely right. I think where people miss the boat, is they feel like they've got a good relationship with their clients. Their clients are going to pay. They always have paid. Everything's good. But they're not really looking a few layers deeper. Who are their clients selling to and who are their clients' clients selling to? That's really where you see a lot of the risk at core. There tends to be a domino effect. Somebody can't pay and your client doesn't have enough days of cash on hand to basically support floating that receivable, and then they can't pay you, and then all of a sudden there's a bankruptcy and there's a ton of people taking huge bad debt losses.


Alix McCabe: Right. Are you able to share any examples of companies that have been hurt by doing business with a zombie firm?


Allen Gebarowski: Yeah, absolutely. There's a few in Oregon, where I'm based. One recently out of Bend, Oregon, there's a construction company who also has a cabinet affiliate, essentially, a subsidiary. They were trading with a bunch of our policy holders. Everything was fine, business as usual, nobody knew there was an issue, and then they filed for bankruptcy out of the blue because they were running into some of the challenges we're talking about today with zombie firms. So I think there is a handful of companies in Bend that took multiple hundreds of thousands of dollars in losses on that bankruptcy-


Alix McCabe: Wow.


Allen Gebarowski: ... and they weren't prepared for it.


Alix McCabe: So if a company's just barely holding on, what can you do as a business owner or CFO to avoid being taken down with them?


Allen Gebarowski: Really, it's about doing your due diligence. If you're not doing at least quarterly or annual credit checks, that's something I would highly recommend people start doing. Have a deeper line of communication with your customers. Ask them how their business is doing. Are they having any delayed payments or DSO kind of getting out there in the weeds? Ask them for their financials, if you can. If they're willing to show their financials, that's always a good place to start. What does their cashflow look like? What does their balance sheet look like? Do they have enough cash to service their debts? And figure out a way to mitigate some of that stuff.

You could use a collections' agency if you want to. You could use your legal recourse if you have legal counsel. But really, in my experience, and after working with a lot of the clients in the Northwest, the best option really comes down to credit insurance, because we're going to do all that work for you.


Alix McCabe: How exactly does credit insurance help protect against zombie firms, or, I guess, put you more in control of the situation?


Allen Gebarowski: Well, if somebody's just relying on payment history and they're not really monitoring someone's credit health ongoing, that's really where Allianz can play a big factor in the success of their company. Not only do we protect against bad debt losses, but we monitor the credit risk and the credit health of the companies our clients are selling to, ongoing. In a lot of cases, we can see the writing on the wall before our clients even are aware and give them a heads- up. We're like that smoke alarm system, letting them know, " Hey, there might be a fire brewing. Maybe mitigate some of your risks now." If we all miss it and it happens, then at least you have the recourse of filing a claim and having us make you whole.


Alix McCabe: So basically, payment history is only one piece of the puzzle. It's more about the intelligence, the forward- looking smoke alarm. I liked how you called it that.


Allen Gebarowski: Yeah, it's really about doing your due diligence. Someone's payment history is not a predictor of their ability to pay in the future. Something I always like to say with my customers when they're considering what they should do and what systems they should put in place to mitigate some of that risk.


Alix McCabe: Building on that more, Allen, can you spitball for me a scenario? Say a new business owner that hasn't previously worked with Allianz before comes on board. How do we alert them of these potential risks and pitfalls that they might be facing?


Allen Gebarowski: That's actually a really good question, Alix. I have a specific example. There's a new customer we just recently brought on. They're a freight broker out of California, but they don't have a very sophisticated credit department yet because they're still a growing company. So they're kind of putting the pieces in place, but they also are really focused on growth. They want to grow their company and get to their revenue goals, so they don't feel like they can turn away any business that's coming through the door. They want to figure out a way to take advantage of every opportunity.

When we got in front of them and did an analysis of their customer profile, looked at their aging, some of their biggest exposures were their worst credit risks, and they had no idea they were in that situation. I think they'd already taken a two or $300, 000 loss, and they're only a two or three year old company, which is pretty big for a $ 2 million, $ 3 million total turnover company. That's a big percentage of their total revenue.

When we looked at some of the other customers they wanted to work with, we saw the same thing. They're taking 100,000, $200,000 in exposure every month, and maybe when we look at their financials for those customers they're trying to sell to, they don't have enough cash to cover their debts. They're over- leveraged. They have a deficit tangible net worth. There's a multitude of reasons, but we were able to basically show them the credit profile of their customers and guide them away from some of those opportunities, and towards some of the other opportunities on their customer list that maybe posed a much better credit risk, more promising, essentially. So they could sell more to those customers to offset a loss revenue with the riskier customers. And I feel like they're doing much better with their company since the partnership.


Alix McCabe: Okay. So they've discovered this now with the information that Allianz has provided. What was the customer's reaction?


Allen Gebarowski: Well, they weren't super thrilled about it, but I think they-


Alix McCabe: They weren't pumped about it. Okay. Clear.


Allen Gebarowski: No, they weren't super excited that the customer they thought was going to be a whale for them wasn't the best credit risk, but I think they had some inklings as well. We had talked about it and they're like, "They started slow paying." That client was 60 days past due already, and they owed them, I think, about $ 150,000 in balance. So they were raising their eyebrows going, " I wonder if we should have maybe vetted this one out a little bit better before we took the opportunity?" So they were relieved to know that we were confirming their suspicions already, but obviously they were disappointed that it wasn't the customer they thought they were getting when they started the relationship.


Alix McCabe: Yeah, and then with the information provided, they could, like you said, redirect their strategy.


Allen Gebarowski: Exactly. There was a few other ones on their list that were in that same boat, they were getting ready to start to do business with. They're picking up loads and orders and shipments and things. So we got them redirected and found... I think there was four or five opportunities that they were completely underselling to, where they could have extended way more credit and really made a huge impact in their revenue goals, in terms of their growth objectives.


Alix McCabe: Okay. So then it's a happy ending?


Allen Gebarowski: Yeah, absolutely.


Alix McCabe: Allen, let's now step back and take maybe a more macroeconomic view of the situation involving zombie firms. A lot of businesses have been through a real stress test over the past few years, like we all have, thanks to the pandemic. What trends have you seen emerge from that period, from that hardship?


Allen Gebarowski: It's interesting you asked that question, because we saw a lot of things happen during the last three years pre and post COVID. The biggest thing that I've seen in terms of just being aware of your own business, is how many days, how many months of cash do the clients you're selling to have on hand? So if they don't get paid by their customer, how long can they sustain making payments to their suppliers and the people they owe obligations to before they can't make those payments anymore? So that was a big takeaway and a big eyeopener, because what we ended up seeing was a lot of customers that our clients were selling to sending furlough letters. " Hey, I know I owe you $500, 000, but I can't pay you for eight more months, so hopefully you're okay if I pay you in October," and it's March.

That really didn't go over that well. We saw a huge increase in claims during COVID for that reason specifically. But then post COVID, we saw all kinds of supply chain disruptions because people couldn't get their product out of Southeast Asia, China, Hong Kong, Singapore. There's a container shortage, there's that shipping disaster. What we ended up seeing is a lot of our customers and their customers panic bought when the supply chains reopened. So now we have people holding way too much inventory at way too high of prices, and they don't have enough margin built in. Now they're trying to figure out how to get rid of that inventory and still turn a profit. They're trying to refinance it. They're trying to get lines of credit off that inventory, and because it's so old, they're having challenges.


Alix McCabe: It's a really interesting turn of events, because I know as consumers, we all remember that period where due to supply chain shortages, nothing would arrive on time. Forget on time, nothing would arrive at all in some cases.


Allen Gebarowski: Exactly. I had clients who were waiting six to 12 months to get the product they had ordered, and they had deadlines to meet with their clients. In some cases, it was actually cheaper to air freight their product over to the States-


Alix McCabe: Wow.


Allen Gebarowski: ... than to rely on marine shipping, which is insane.


Alix McCabe: Okay, I hate to cut our conversation short, Allen, but I'm hearing the music, and that means we're out of time. We do have lovely parting gifts for you though, including a very coveted Wheel of Risk T- shirt, which is quite posh, I must say. So you'll get one of those. Before we say goodbye, okay, what would you say your final word of advice would be to our audience?


Allen Gebarowski: My final word of advice really would be, just make sure you're doing your due diligence. Whether you have credit insurance as a tool in your toolkit or not, it's really important that you're doing periodic credit checks on your customers, you're asking for financials if they're willing to share them, to make sure you're protected, especially with some of the customers that you've had long- term relationships with. I have had clients whose best customers were at their wedding. Maybe they're the best man at the wedding. They go on camping trips together. They feel like there's no chance those customers will ever not pay them. They'll always try to make it right, and honestly, they will, until they can't.

In fact, in those situations, you're probably the last person they're going to tell because they're so embarrassed that they can't pay, and they're running into issues. So just make sure you're doing your due diligence, you're making sure you have your risk mitigated. And if you need help, that's what we're here for. Reach out to somebody at Allianz Trade. Reach out to myself, one of the other sales agents, and we'll be happy to walk you through some of the examples of how you could apply it to your business and see if it makes sense.


Alix McCabe: Thanks, Allen. It's been really wonderful having you on the show. And happy Halloween.


Allen Gebarowski: Happy Halloween.


Alix McCabe: My guest today has been Allen Gebarowski, regional vice president, Northwest Region, at Allianz Trade. My thanks also to Dan North, our senior economist for North America. I'm Alix McCabe, and this is Wheel of Risk, brought to you by Allianz Trade. Thank you so much for listening. If you learned something, we'd absolutely appreciate it if you could leave us a positive review. To learn more about how a partnership with Allianz Trade can benefit your organization, please visit allianz- trade. us/ podcast. That's A- L- L- I- A- N- Z dash trade. us/ podcast. Talk to you soon and stay safe out there.