Too early to tell if Toys ‘R’ Us severance fund will become industry standard

Toys ‘R’ Us, once the largest toy retailer in the country, is now the third-largest retail bankruptcy in history – potentially changing the discourse of private equity-backed retail.

Multiple media reports last week suggested Bain Capital and KKR are putting together a $20 million severance fund. The pool of money would benefit over 30,000 workers who were left without any exit pay when the now-defunct toy store operator decided to liquidate in March.

While it is too early to tell if it will drastically change the landscape of deals and negotiations, severance funds may become a back-of-mind at the negotiation table, a former Toys ‘R’ Us analyst told sister publication PDI.

Sean McGowan, who covered the company before the ill-fated 2005 buyout at Harris Nesbitt Gerard, said that though public outcry when household names go under is common, this is the first time he has heard of a severance fund being created by the private equity sponsors.

McGowan, who is now a managing director at capital markets advisory firm Liolios, said because private equity firms may emerge from corporate bankruptcies relatively unscathed, he does not believe the Toys ‘R’ Us situation will impact private equity firms’ willingness to do deals in the retail space. He does think, however, it will influence the conversations between buyout shops and potential portfolio companies.

“If it works well, and gets a lot of positive publicity, a company in the midst of negotiating a sale might say, ‘Hey why don’t we set up a provision in advance in case of failure,’” McGowan said.

He also said if a private equity-backed company sinks deeper into financial distress, it may now feel worker severance is an appropriate point of discussion, given the precedent now established.

The Minnesota State Board of Investment, which has committed over $1 billion to various KKR private equity, credit and infrastructure funds, decided to suspend commitments to the firm after hearing from the Private Equity Stakeholder Project about concerns over lack of severance pay.

In addition, KKR and Bain faced political pressure. Some 19 Democratic senators wrote a letter expressing their dismay with the situation. The letter attacked the leveraged buyout model, specifically citing Toys ‘R’ Us making $150 million in operating profit annually but failing to make their $400 million annual interest payment.

Both Bain Capital and KKR Capital declined to comment.

Wayne, New Jersey-based Toys ‘R’ Us was bought in 2005 for $6.6 billion by Bain, KKR, and Vornado Realty Trust. After years of struggling to compete with growing retailers like Walmart and Amazon, along with the debt burden associated from the buyout, Toys ‘R’ Us filed for bankruptcy in September 2017 seeking $3.13 billion in debtor-in-possession financing, PDI reported at the time.

The company formally decided to liquidate the company in March 2018, after a disappointing holiday season. Both Bain and KKR have said that they wanted Toys ‘R’ Us to restructure rather than liquidate. Stores officially closed on 29 June.

This week, the current lenders, including Solus Alternative Asset Management and Angelo Gordon, cancelled plans to auction off Toys ‘R’ Us’s intellectual property and are looking to potentially revive the brand.

Solus Alternative Asset Management could not be reached for comment by press time, and Angelo Gordon declined to comment.