Clothing chain J.Crew has filed for bankruptcy protection. Like numerous other retailers, the peddler of preppy classics has seen its business suffer during the ongoing Covid-19 outbreak. Fashion has been hit especially hard. In March, sales at clothing stores were down more than 50% versus the prior year.
But the pandemic just brought to a head troubles for J.Crew that have their roots in 2011, when two private-equity firms bought the American retailer for $3 billion in a leveraged buyout. It left J.Crew carrying an immense amount of debt it was never able to escape. When the pandemic hit, the burden was too much to bear—a scenario likely to repeat itself at other retailers before the crisis ends.
“This wasn’t because of the pandemic. This was because of the debt load,” says Eric Snyder, partner at law firm Wilk Auslander and chairman of its bankruptcy department. He calls private equity “the two dirtiest words in retail,” and says the industry has been seeing more companies backed by private equity failing because of their debt.
Leveraged buyouts have become common among private-equity firms looking to prop up companies they think offer good potential return on their investment. It involves buying a company using debt, much like taking out a loan to pay for a large purchase. Except in this case, it’s the acquired company that’s responsible for the debt, while the acquirer gets a share of ownership. Often private-equity firms are looking for a quick return on the investment, and will support the company for three to five years before seeking an exit, such as an IPO or a sale.
But the process can leave the acquired company grasping for a quick turnaround under debt it can’t sustain, making it hard to get new financing and hurling it toward bankruptcy. The acquirer, meanwhile, might still have recouped its initial investment before that happens, or profited in other ways.
J.Crew’s announcement said it had $1.65 billion in debt, against $1.6 billion in total assets as of Feb. 1, with current assets of $497 million. It had been unable to fix sales at its namesake brand, and recently suspended its plan to raise money with an IPO of its successful Madewell denim brand. Unable to manage the debt, J.Crew is now handing ownership of the company to its creditors, including Anchorage Capital Group, GSO Capital Partners—a division of investment group Blackstone—and Davidson Kempner Capital Management. The firms are also giving J.Crew $400 million in new financing to support it during its restructuring.
Other examples of retailers driven into bankruptcy by private equity include Sports Authority, Toys R US, Barneys, and Payless Shoes. A July 2019 report (pdf) by progressive nonprofit and worker-advocacy groups said 10 of the 14 biggest bankruptcies from 2012 to that point were at chains bought by private equity.
Private equity’s defenders argue it’s no different than any other means of raising capital and unfairly disparaged. These companies certainly all had serious problems in their businesses related to structural shifts in retail more broadly.
But Snyder argues the debt load from a buyout can be difficult to manage even if the company is otherwise stable. A downturn such as the pandemic “makes it impossible,” he says.