When Private Equity Gutted Toys "R" Us
How private equity loaded Toys "R" Us with debt and put the iconic toy store out of business.
One of my favorite traditions as a kid was looking through the Toys “R” Us holiday catalog every year. When I needed inspiration for my Christmas list, Toys “R” Us never failed to deliver. My lists were often ambitious, and that was very much reflected in what actually ended up under the tree on Christmas morning. Indeed, I couldn’t get everything I wanted from what was once every kid’s favorite store. One group, however, seemed to believe there was no limit to what they could get from Toys “R” Us: the private equity firms Bain Capital and Kohlberg Kravis Roberts (KKR).
In 2005, Bain Capital and KKR, along with the real estate group Vornado Realty Trust, acquired Toys “R” US for $6.6 billion.1 At the time of the acquisition, the toy company was facing fierce competition from discount department store chains such as Walmart and Target. Additionally, the rise of e-commerce also began to pose a significant threat to the toy giant’s business operations. Why waste gas driving to the nearest Toys “R” Us when you could order your child’s birthday gift on Amazon? Perhaps new ownership could be just what Toys “R” Us needed to meet the moment. Instead, the 2005 acquisition ultimately sealed the beloved toy retailer’s fate. Private equity ended up dealing more damage to the company than any of its business rivals ever could.
How private equity firms work
Before diving into the case of Toys “R” Us, it is important to understand how private equity firms generally operate. Brendan Ballou, who previously served as Special Counsel for Private Equity at the U.S. Department of Justice, details the fundamental business structure of private equity firms in his 2023 book, Plunder: Private Equity’s Plan to Pillage America:
“To make its business model work, the private equity firm needs money, which it gets from three sources. The firm itself contributes a small percentage of the funds needed to buy the company, while the firm’s investors—pension funds, sovereign wealth funds, wealthy individuals, and the like—provide some of the rest necessary for the acquisition. The firm then leverages all those assets… to borrow most of the money it needs from banks and other lenders. Crucially, the responsibility for paying back the money the firm borrows sits not with the firm itself but with the company it buys. Thus, if the company fails, the private equity firm loses only its small initial investment.”2
As such, private equity firms contribute only a small portion of the capital themselves, raising most of it from wealthy investors. This investor capital is then used to help secure additional funding from banks and other lending institutions, thus allowing the private equity firm to proceed with acquiring a specific company. This process is known as a leveraged buyout (LBO), defined by Investopedia as, “…the acquisition of one company by another using a significant amount of borrowed money to meet the cost of acquisition.”3 Given that the private equity firm is primarily using borrowed money to purchase a company, you would expect that such an acquisition would burden the private equity firm with debt. However, this is not the case, and the burden of the debt is actually placed on the company that is acquired, not the private equity firm itself. In the case of Toys “R” Us, the toy company “…took on $5 billion in debt virtually overnight.”4
Private equity squeezed the life out of Toys “R” Us
After acquiring Toys “R” Us, KKR and Bain began extracting as much wealth as possible out of their new purchase. The private equity partnership proceeded to sell off the toy company’s real estate and forced the retailer to lease back its buildings, all while pocketing the money.5 This financial transaction is known as a leaseback, “…an arrangement in which the company that sells an asset can lease back that same asset from the purchaser.”6 The leaseback arrangement, often a significant source of revenue for private equity firms, is typically fatal for the acquired company. It makes sense when you think about it from a business standpoint. If your company actually owns its property instead of leasing it, you don’t have to worry about meeting rent payments. Additionally, the assets can serve as collateral if your business needs to borrow in bad times.
As Ballou explains, leasebacks are “…a great source of revenue for private equity because [they allow] the firm to post a quick profit and often take a transaction fee along the way.”7 However, it is typically quite detrimental for the underlying business. If your company is burdened with ongoing expenses and you already lack assets, it becomes very difficult to survive harsh business cycles. When you consider that Toys “R” Us had been paying down roughly “…$400 million in annual interest leftover from its leveraged buyout…”8 and was already struggling to keep up with fierce competition from rivals such as Amazon, the company was quite vulnerable. This, in addition to the fees and interest that Toys “R” Us paid out to KKR, Bain, and Vornado, left the company reeling.
The Private Equity Stakeholder Project estimated that KKR, Bain, and Vornado collected $464 million in fees and interest from Toys “R” Us while thousands of workers lost their jobs.9 This is because the private equity model is primarily used to “…loot and flip, not to invest or run companies well.”10 In other words, the actions of such firms are not genuine efforts to invest in productive businesses, but rather to extract as much wealth as possible while putting many out of work. According to Aliya Sabharwal, who organized on behalf of the laid-off Toys “R” Us workers, the private equity partnership “…eliminated positions and offloaded responsibilities onto other employees, while pressuring workers to sign up customers for high-margin sweeteners like credit cards and ‘payment protection plans.’”11
Instead of investing in technology to keep the business competitive (such as upgrading their website), or other innovative ways to modernize in the age of e-commerce, Toys “R” Us was paying hundreds of millions of dollars a year in interest leftover from its leveraged buyout, in addition to the millions of dollars paid annually to its private equity owners in management and advisory fees. While many at the time had blamed its struggling business on the rise of Amazon and e-commerce, the real issue at hand was the debt. As Ballou notes, “Toys’ sales remained steady, even during the Great Recession, and in the year before it filed for bankruptcy, its $11 billion in revenue accounted for an estimated one-fifth of all toy sales in the country.”12 Drowning in debt, the toy company filed for bankruptcy in 2017 and officially closed its doors in June 2018.13
Aftermath
Over 30,000 Toys “R” Us employees lost their jobs when the company officially shuttered in 2018.14 Even more outrageous, the laid-off employees were initially denied severance.15 The laid-off workers would later win a $2 million severance agreement, though this resulted in only about $34 each for part-time workers and $60 for full-time workers.16 The private equity owners also provided a $20 million “hardship fund” for the former employees, though this amount was significantly lower than the $75 million in severance workers were originally promised.17 It is also worth noting that lawyers from Kirkland & Ellis were awarded some $56 million in fees for representing Toys “R” Us during the bankruptcy case.18
CEO David Brandon even received $2.8 million in the form of a retention bonus just before the store’s bankruptcy was filed.19 Before receiving this payment, Brandon had been informed by company lawyers that his bonus would likely not be approved once bankruptcy was officially filed. He then ordered bonuses for himself and other top executives to be paid just three days before the filing.20 An employee at a shuttering Babies “R” Us location in New Hampshire shared her frustration over the closures and executive bonuses in an email to Brandon. The CEO had initially promised all of the employees at the New Hampshire location severance, before informing them they would no longer receive it about a week later.21 Brandon responded to the laid-off worker directly by saying, “While there is nothing I can do or say to make you feel any better about the very painful situation we are living through… I want you to know that I share your pain."22 He also insisted that there would be no bonuses received by himself or other executives. Toys "R" Us later disclosed in court that it paid CEO David Brandon the $2.8 million retention bonus just before filing for Chapter 11 protection, contradicting his claims.23
If you’re reading this feeling frustrated, the case study of Toys “R” Us and private equity is unfortunately not all that unique. Private equity has only grown more powerful since the start of the 21st century. So many once iconic companies have been destroyed under the ownership of private equity. RadioShack. Mattress Firm. Claire’s. Aeropostale. Fairway. Sports Authority. David’s Bridal. American Apparel. All of these companies ultimately filed for bankruptcy after being purchased by private equity firms.24 You could write a whole book about how private equity has wreaked havoc on so many lives and businesses. Thus, I highly recommend you check out Plunder: Private Equity's Plan to Pillage America by Brendan Ballou. Private equity has already reshaped the American economy in so many ways you likely haven’t even realized. Toys “R” Us is just one example.
https://www.sec.gov/Archives/edgar/data/899689/000110465905033479/a05-13329_1ex99d1.htm
Ballou, Brendan. Plunder: Private Equity's Plan to Pillage America. First edition. PublicAffairs, 2023, p. 20.
https://www.investopedia.com/terms/l/leveragedbuyout.asp
https://theeconinsider.com/private-equity-and-asset-stripping-the-fall-of-toys-r-us/
https://www.latimes.com/opinion/story/2023-08-11/simon-schuster-deal-paramount-kkr-private-equity
https://www.investopedia.com/terms/l/leaseback.asp
Ballou, Brendan. Plunder: Private Equity's Plan to Pillage America. First edition. PublicAffairs, 2023, p. 22.
https://www.retaildive.com/news/one-year-later-toys-r-us-fatal-journey-through-chapter-11/532079/
https://pestakeholder.org/news/kkr-bain-capital-vornado-repeatedly-rewarded-themselves-for-adding-debt-to-toys-r-us/#_ednref4
https://www.latimes.com/opinion/story/2023-08-11/simon-schuster-deal-paramount-kkr-private-equity
Ibid.
Ballou, Brendan. Plunder: Private Equity's Plan to Pillage America. First edition. PublicAffairs, 2023, p. 62.
https://www.cnbc.com/2018/06/29/toys-r-us-closes-its-doors-on-friday-leaving-beind-nostalgia-anger-a.html
https://www.cbsnews.com/news/toys-r-us-closing-messy-ending-leaves-workers-customers-hanging/
https://www.wnyc.org/story/laid-employees-protest-toys-r-us-refusal-provide-severance-after-bankruptcy/
https://d12v9rtnomnebu.cloudfront.net/paychek/TRU_severance_settlement.pdf
https://www.retaildive.com/news/toys-r-us-owners-to-set-up-employee-fund/538518/
https://www.cbsnews.com/news/bankruptcy-court-gives-toys-r-us-workers-2-million-and-retailers-lawyers-56-million/
https://www.startribune.com/laid-off-toys-r-us-workers-20m-win-is-just-one-example-of-burgeoning-retail-labor-movement/501599141
https://www.dovel.com/wp-content/uploads/2020/03/tru-complaint.pdf
Ibid.
Ibid.
https://www.axios.com/2017/12/15/bankrupt-toys-r-us-asks-court-to-okay-huge-executive-bonuses-1513307127
Ballou, Brendan. Plunder: Private Equity's Plan to Pillage America. First edition. PublicAffairs, 2023, p. 4.
Nick, just wanted to note that private equity was also responsible for the closure of JoAnn Fabrics and Crafts as well. I won’t shop at Hobby Lobby or Michael’s either.