Private equity’s dilemma Why so many firms are stuck with unsellable zombie companies

The private equity industry is confronting a growing and uncomfortable reality. After a decade of deal making driven by cheap credit and eager capital, many buyout firms now sit on a rising inventory of portfolio companies that neither thrive nor die. These so called zombie companies are businesses that generate just enough cash to keep operating but lack the growth momentum or margin expansion that would attract buyers at acceptable prices. For private equity managers the problem is existential. They cannot easily exit these assets and doing so at depressed valuations would harm returns for limited partners and damage future fundraising prospects.

The emergence of zombie companies reflects a confluence of factors. Rising interest rates over recent years increased the cost of leverage that once fuelled buyouts. A tighter credit market and more conservative loan underwriting reduced the pool of strategic and financial buyers able to take on leveraged deals. Meanwhile, public market multiples for many sectors have retraced from their peaks, narrowing options for secondary sales or initial public offerings. All of this matters because private equity relies on exits to realise gains. When exits stall the machinery of the industry grinds down into a slower, more painful cadence.

How assets become zombies and why they linger

Assets can become zombies for several reasons. In some cases a firm overpaid at the top of a cycle assuming continued margin expansion and benign financing conditions. When those assumptions proved optimistic the company’s growth could not justify the valuation. In other cases operational improvements fell short. Private equity owners typically plan to boost efficiency, refocus management and expand sales through strategic investments. If those measures fail or take longer than expected the business may produce flat cash flows that are unattractive to potential acquirers.

A third pathway to zombification is sectoral change. Companies embedded in industries undergoing structural decline or technological disruption face headwinds that are not easily overcome by operational tweaks alone. Strategic buyers avoid acquiring distressed players whose long term prospects remain uncertain. Financial buyers are reluctant to pay meaningful premiums for assets with limited upside potential. The result is a cohort of companies that earn enough to pay interest and meet basic obligations but cannot support the capital expenditure or innovation needed to transform competitive positions.

Why do these companies linger in private equity portfolios rather than being written down or sold? The answer lies in incentives and market realities. Fund managers have limited time windows to liquidate holdings and deliver returns to investors. Selling at poor prices would crystallise losses and tarnish track records. Instead many managers opt to extend hold periods, injecting minimal capital to maintain solvency while hoping for improved market conditions. For limited partners this practice prolongs illiquidity and concentrates risk in older vintages that were expected to have been realised years earlier.

The consequences for funds investors and the wider market

A proliferation of zombie assets carries material implications. For funds the immediate effect is lower realised returns and a drag on internal rate of return metrics that determine investor satisfaction and fundraising success. Managers facing persistent unsold assets may struggle to raise new funds. That has already been visible in the market where many smaller or newer firms find it difficult to attract fresh commitments while established managers with strong track records continue to access capital at scale. The result risks a bifurcated industry with fewer active entrants and greater concentration among top tier firms.

Limited partners feel the pain in multiple ways. Illiquid portfolios reduce the ability of institutional investors to rebalance allocations across asset classes and to meet redemption needs without selling other holdings at inopportune times. Pension funds and endowments rely on private equity distributions to meet long term liabilities. When those distributions slow the broader portfolio construction becomes more complex and dependent on public market performance.

The market wide consequences should not be understated. Zombie companies absorb capital that could be more productively deployed elsewhere. They may also contribute to inefficient allocation across the economy by keeping alive firms that would otherwise be restructured, consolidated or allowed to fail. That persistence can blunt competition and slow necessary industry level transitions, for example by delaying consolidation in fragmented sectors or hindering the reallocation of skilled labour to higher growth opportunities.

Strategies to revive or manage zombies and why they are imperfect

Private equity managers have several levers to address zombie companies, but each comes with trade offs. One approach is deeper operational intervention. That means replacing management, investing in digital transformation, pruning unprofitable business lines and sharpening commercial strategy. For companies with latent potential this can pay off. However such turnarounds take time and cash, and they succeed only when the underlying market supports improved performance.

Another option is strategic consolidation. A manager may combine a zombie asset with another portfolio company to create scale and cost synergies that enhance appeal to buyers. Consolidation can reduce duplication and generate new growth avenues, but it requires compatible businesses and sometimes regulatory clearance. When consolidation is feasible it can create value. Often, though, synergies are limited and execution risk is high.

Some firms pursue structured exits with creative financing. They may offer earnouts, seller financing or retain minority stakes while bringing in strategic partners. Those solutions can unlock liquidity and preserve upside for the seller. Yet they also expose the seller to future performance risk and may not generate the immediate capital needed to satisfy investor expectations.

In more severe cases managers negotiate debt restructurings or partial write downs with lenders to stabilise cash flows. That route can reduce interest burdens and provide breathing room, but it typically results in equity dilution and can signal distress that deters potential buyers. Using restructuring to buy time is sometimes necessary but rarely resolves the core issue of limited buyer demand.

A more fundamental response involves changing fund structures and expectations. Some firms are increasingly transparent with limited partners about extended hold periods and are seeking consent for longer horizons in order to maximise recoveries. Others are experimenting with secondary market sales of fund stakes or of individual portfolio companies to specialist turnaround funds that have the patience and operational expertise to manage distressed assets. These secondary solutions generate partial liquidity but often at a discount, and they do not scale easily when an industry faces a large volume of troubled assets.

Longer term structural questions persist. How many private equity firms are viable in an era where exits are slower and valuations more conservative? Will the industry re calibrate its fund lifecycles and performance benchmarks to reflect longer realisation windows? Answers will shape the future composition of private capital and its role in the broader economy.

The rise of zombie companies in private equity portfolios is a symptom of broader market adjustments. Years of abundant credit amplified deal volume and lifted valuations, but higher rates and tighter lending conditions have exposed weaker business models and extended exit timelines. For managers the choice is stark. They can sell at depressed prices and crystallise losses or they can hold and hope for better markets while enduring strained relations with investors. Limited partners must weigh patience against the opportunity cost of locked up capital. For the economy the persistence of zombie companies raises efficiency and productivity concerns.

There is no single silver bullet. Operational improvement, consolidation and creative financing can rescue some assets. Greater transparency and realistic fund terms can help align incentives. Specialist buyers and secondary markets provide partial relief. But the industry also faces a more sober reality: a recalibration of expectations and a period of slower exits may be the new normal. How private equity adapts will determine not only the fate of zombie companies but also the resilience of an entire asset class that has been a major force in global corporate finance.

Written by Nick Ravenshade for NENC Media Group, original article and analysis.
Sources: CNBC, Cliffe Dekker Hofmeyr, BNR Nieuwsradio, Advisor Perspectives Bloomberg, MSCI Research and Insights.