Evidence of a declining retail industry is rearing its ugly head across the United States: strips of empty store fronts along a once-bustling Broadway in New York City, the appearance of “ghost malls” in American suburbs[1], and a marked increase in Chapter 11 bankruptcy filings by major retail companies in the past year.[2] The expansion of online shopping, spurred by proverbial e-commerce giant Amazon, has undoubtedly drawn consumers away from brick-and-mortar retail stores.[3] However, the fate of struggling retail companies has been further complicated by the role that private equity firms (“PE Firms”) play in their acquisition of such companies. Specifically, PE Firms’ management of retail companies may be responsible for an increase in bankruptcy filings by the companies, and losses to third parties such as vendors and landlords.[4]
In broad terms, PE Firms raise capital from investors and use it to acquire distressed companies[5] in a wide variety of sectors, including the retail industry.[6] Following the acquisition of a distressed company, a PE Firm will attempt to transition the company out of debt with the goal of selling it for a profit.[7] Despite their stated intention to push companies out of the red, PE Firms’ models are focused on maximizing profit, which can be detrimental to the financial health of the debt-laden companies that they acquire and have the opposite effect by sending companies further into debt.[8] Specifically, PE Firms can substantially contribute to a distressed company’s financial regression through actions such as: (i) acquiring the company’s existing debt obligations through a Leveraged Buyout (“LBO”),[9] (ii) collecting dividends from the company based on those obligations, and (iii) charging the company with the PE Firms’ management fees.[10]
When PE Firms take actions like those described above in their management of distressed retail companies, the downside for retailers can be severe. A retail company can attempt to reduce debt by closing stores, terminating leases, laying off employees, or decreasing inventory.[11] However, this course of action results in a Catch-22: “Some retailers end up shuttering stores to save money, but are often in a bind because they need to keep their shelves stocked with inventory to attract consumers, as well as retain enough staff to deal with customers and ensure a pleasant shopping experience.”[12] Closing physical store locations often causes retail companies’ revenue to dwindle, leaving them unequipped to pay the mounting debt resulting from their initial LBOs.[13]
A recent example of a distressed retailer that suffered under PE Firm management involved Payless Shoes (“Payless”), which was acquired by Golden Gate Capital (“Golden Gate”) and Blum Capital (“Blum”) in 2012.[14] In the span of only two years, Golden Gate and Blum collected $350 million in dividends in each of 2013 and 2014 in connection with debt acquired through Payless’ LBO, which caused Payless to take on over $700 million in debt.[15] Like the scenario described above, Payless had additional debt obligations stemming from its physical store locations through leases from third party landlords and inventory from vendors.[16] When Payless’ debt (the majority now owned by Golden Gate and Blum) began to spiral, the company closed store locations in an effort to curtail its losses, but the storefront closures caused an even further decline in revenue.[17] In April 2017, Payless filed for Chapter 11 bankruptcy, leaving its vendors and landlords with little hope of recovering on their claims[18] while the PE Firms made a generous profit.[19]
As major U.S. retail companies like Payless continue to deteriorate under their supervision and management, PE Firms appear to be developing a trend of avoiding acquisition of distressed retailers altogether.[20] While the future of the American retail industry remains unclear, a strategic choice by PE Firms to shy away from distressed retail companies may in fact be beneficial to retailers in the long-run, as they can avoid potentially insurmountable debt resulting from PE Firms’ management practices.
[1] Courtney Reagan, Leslie Picker, It’s More Than Amazon: Why Retail is in Distress Now, CNBC (May 5, 2017) https://www.cnbc.com/2017/05/05/its-more-than-amazon-why-retail-is-in-distress-now.html.
[2] Adam Lewis, PE Firms Shying Away From Struggling Retail Industry, Pitchbook (June 14, 2017) https://pitchbook.com/news/articles/pe-firms-shying-away-from-struggling-retail-industry.
[3] See Reagan, supra note 1.
[4] Lillian Rizzo, Private Equity Takes Fire as Some Retailers Struggle, Wall Street J. (July 30, 2017) https://www.wsj.com/articles/vendors-landlords-target-private-equity-firms-in-retail-rubble-1501412401.
[5] A distressed company is one that cannot meet or has difficulty making its financial obligation to creditors. See Financial Distress, http://www.investopedia.com/terms/f/financial_distress.asp (Last visited Oct. 13, 2017).
[6] Many distressed retail companies were acquired by PE Firms after the financial crisis of 2008 due to low interest rates. See supra note 4; Aimee Picchi, The Internet Isn’t the Only Thing Killing U.S. Retailers, CBS Moneywatch (May 12, 2017) https://www.cbsnews.com/news/the-internet-isnt-the-only-thing-killing-u-s-retailers/.
[7] See Picchi, supra note 6.
[8] See Jonathan Macey, How Private Equity Works, Wall Street J. (Jan. 13, 2012) https://www.wsj.com/articles/SB10001424052970204124204577154521024107002.
[9] A Leveraged Buyout refers to the takeover of a company that utilizes mainly debt to finance the buyout. The company performing the LBO or takeover (the PE Firm) only has to provide a small amount of financing yet is able to make a large purchase. See What is a Leveraged Buyout, Wall Street Oasis, https://www.wallstreetoasis.com/finance-dictionary/what-is-a-leveraged-buyout-LBO (Last visited Oct. 13, 2017). The technical aspects of a Leveraged Buyout are beyond the scope of this article.
[10] Id.
[11] See Picchi, supra note 6.
[12] Id.
[13] Id.
[14] Id.
[15] Id.
[16] See Rizzo, supra note 4.
[17] See Sheena Butler-Young, Payless to Open Super Stores and Close Outposts, Footwear News (Sept. 6, 2016) http://footwearnews.com/2016/business/retail/payless-shoesource-close-500-stores-open-super-stores-ecommerce-254182/l; See Picchi, supra note 6.
[18] The landlords and vendors are “unsecured creditors,” meaning that their claims in the bankruptcy proceeding are superseded by secured creditors, whose claims are tied to collateral. See LaToya Irby, The Difference Between Secured and Unsecured Debts, The Balance (June 10, 2016) https://www.thebalance.com/the-difference-between-secured-and-unsecured-debts-960181; See Picchi, supra note 6.
[19] See Rizzo, supra note 4.
[20] See Lewis, supra note 2.
