Like an old flame returning years after a spat, private equity is back knocking on retail's door.

Kohl's is one of the most recent to be wooed. Reports had it that the company received interest from private equity player Sycamore Partners, a familiar face in the retail industry that is also openly pursuing ODP Corp's retail business (which includes Office Depot and OfficeMax). 

The Wall Street Journal also reported that Acacia Research, owned by activist firm Starboard Value, offered $9 billion to buy Kohl's and had banks vouching for its ability to finance the deal with debt. 

The retailer opted not to sell itself (for now) in a leveraged buyout, citing essentially a too-low price and adopting a poison pill to head off any potential hostile takeover. But the company has left open the possibility of a sale at a higher price, and is facing intense activist pressure over its refusal to further engage private equity suitors. 

Kohl's is just the latest to be courted. Retail has a decades-long history of private equity interest and leveraged buyouts. As a hot mergers and acquisitions market rolls on and bids come in for retailers, it's worth taking a moment to look at that history, which is littered with bankrupt, liquidated and distressed retailers. 

Retail, buyouts and bankruptcy

Historically, private equity buyers of legacy retail companies have financed their acquisitions with debt, which then becomes the responsibility of the acquired company. Leveraged buyouts took off in the 1980s, fueled by the development of high-yield junk bonds and the formation of private equity funds focused on taking public companies private to wring more value and efficiency out of them. 

Private equity deals in the retail industry have ebbed and flowed over the decades. Interest in retail has returned following a drought likely pegged to retail's struggles over the latter part of the 2010s. 

There were just four major private equity acquisitions of retailers in 2018, and next to none in 2019 and 2020, according to Retail Dive's tracking. In 2021, there were eight acquisition deals for major retail companies, along with investments in and acquisitions of brands and digital retail ventures.

Last year, for example, brought the acquisitions of At Home by Hellman & Friedman, Casper by Durational Capital Management, Michaels by Apollo Global Management and Paper Source out of bankruptcy by Elliott Investment Management, among others. 

Since 2018, Retail Dive has compiled a database of private equity acquisitions in the industry going back two decades. Our initial list was made in part with data provided by PitchBook and Acuris as well as Retail Dive research. Since then, subsequent additions and updates to the list have been made with Retail Dive research. 

All told, the list includes more than 110 retailers that have gone through at least one private equity acquisition at some point going back to the 2000s. Of them, over 40% have filed for bankruptcy at some point after their acquisition, according to Retail Dive's analysis.

That is a troubling track record. It's important to note that private equity's strategy often involves purchasing companies that are already struggling and attempting to turn them around. In other words, not all the blame for a company's failure can be laid at the feet of private equity firms. 

Yet the dozens of bankruptcies also raise serious questions about the wisdom and efficacy of loading up struggling companies with millions or even billions of dollars in debt to finance private equity's merger strategy (and the occasional debt-financed dividends). 

While buyouts add debt, acquired retailers often go through years of disinvestment while they try to manage their interest expenses, all the while potentially paying management fees and dividends to their sponsors. Toys R Us, to take a famous case, let its stores deteriorate and competitive position flag under a $5 billion debt load from a private equity buyout. All the while executives and owners were taking cash out of the company. Ultimately the company collapsed in bankruptcy. 

"It's a snowball effect," said Dennis Cantalupo, CEO of Pulse Ratings. "The debt starts it, and then you're spending so much of your capital servicing that debt you're not investing into the business as much, and your business starts to suffer."

A brief history of a bad deal

Despite the potential for financial distress after a leveraged buyout, boards and executives of publicly traded retailers have every incentive to sell to private equity bidders, if the price seems right. The higher the price, though, the higher the potential debt load. 

With stock used to compensate company leadership, those making the decision to sell can collectively make millions along with a company's shareholders. Often, management teams and directors are replaced after a deal, and it may not seem like their problem when reviewing a bid. 

Yet, in a leveraged buyout where the debt is so high it renders the company insolvent, board directors and executives face potential liability for doing the deal. 

Enter the Jones Group. The apparel company once owned Nine West, Stuart Weitzman, Kurt Geiger, Anne Klein and a host of other brands. In 2014, it completed a deal to sell itself to Sycamore Partners, which over the years has bought Talbots, Hot Topic, Belk, Staples, Coldwater Creek and other retailers and brands.  

Sycamore bought the Jones Group for $15 a share, an increase from an initial bid of $14 (though considerably less than what Sycamore originally floated, after getting a closer look at the company's books). Initially, Sycamore planned to put up $395 million of its own money to cover the price but eventually cut that figure by more than half, leaving it with little skin in the game. Instead, the firm increased the amount of debt used to finance the deal. 

This is all according to former creditors to Nine West, who alleged in a lawsuit that Sycamore's acquisition rendered the Jones Group insolvent.

The firm, they say, sold itself the best parts of the Jones Group — the fast growing Stuart Weitzman and Kurt Geiger brands — for far less than their market value and out of the reach of creditors. The remaining brands were mostly struggling — including Nine West, which would lend its name to the new company — and bundled into a new company that was left with $1.5 billion of debt from the buyout. (Sycamore declined to comment for this story.)

The complicated transaction, plaintiffs say — based on a years-long investigation that has turned up internal documents and testimony — was premised on Sycamore's projections of future profits and sales for the Nine West brands that were rosy and out of step with its actual performance. 

The numbers included future sales growth for brands that had only declined in recent periods while ignoring things like lost sales from store closures, ongoing consulting costs and the impact of shedding all of the company's then-current leadership changes for the company, according to the plaintiff's allegations. 

The combination of debt and a declining business indeed drove Nine West into bankruptcy roughly four years later. The suing creditors argued that the company became insolvent the moment the deal went through and that, therefore, not only Sycamore but the Jones Group leadership that agreed to the deal were liable for Nine West's ultimate destruction. 

Approving the merger, according to the plaintiff's argument, amounted to a breach in fiduciary duty. "Jones Group's directors, officers, and shareholders collectively had walked away with almost $1.2 billion," the complaint states. "By contrast, [Nine West] was deprived of its prize assets and left with shrinking, low-profit businesses and a huge debt load." 

Director defendants in the case asked a federal court to dismiss claims that they had violated their fiduciary duty but were denied, the judge in the case finding that company leaders hadn't sufficiently investigated whether the Jones Group deal would render the company insolvent.

A few months after that decision, before the parties went to trial, the litigation against the former directors and executives was settled. (A case against former investors who profited from the Jones Group sale is ongoing.)

'You can't bury your head in the sand'

The history of Jones Group and Nine West is, obviously, specific. But it is also instructive, and it raises questions about what corporate decision-makers at Kohl's and others need to do and know when considering a bid from private equity investors planning a leveraged buyout. 

Developments in the case, including the judge's refusal to dismiss claims, were a "natural extension of bad facts," said Keith Sambur, a partner with Holland & Knight's financial services practice. "Jones Group pushed the envelope as it relates to the amount of leverage on a company."

At the same time, as Sambur points out, corporate leadership has a fiduciary duty to their shareholders and could face lawsuits from investors for not considering a serious deal. Solvency is key here in determining which responsibilities take precedence. 

"You have to make sure that the company isn't so immediately saddled with debt that the LBO transaction rests solely on the back of unsecured creditors," Sambur said. "To me, what Jones says at the end of the day is you can't bury your head in the sand and say, 'I'm just going to pretend that's not on my watch.' You have to make that determination through a modicum of due diligence, which did not happen here."

Future lawsuits may be the only real recourse vendors and other unsecured creditors have. They might not like leveraged buyouts, but suppliers still need their retail customers and some of the biggest retailers that take on the biggest debt loads tend to be important customers to suppliers. Yet wariness in the supply chain adds even more to a leveraged retailer's financial risks. 

"Suppliers are not obligated to do business with anybody," Pulse Ratings' Cantalupo said. After a leveraged buyout, vendors "reassess the credit profile and, if they're comfortable with it, they continue selling to them. If the credit deteriorates, then you may see suppliers scale back exposure, maybe lower credit lines, change the payment terms, things of that nature."

If vendors reduce their exposure to a retailer enough, Cantalupo added, retailers "are not getting [enough] goods and your sales are dropping. It's a vicious cycle."