Not Fun and Games: The harsh consequences of a crushing debt burden

The Bain Buyout of KB Toys

In December 2000, at the height of the busy Christmas shopping season, Bain Capital purchased KB Toys in a highly leveraged buyout worth $300 million. Bain invested only $18.1 million of its own money and financed the rest with bank loans and other assorted I.O.U.s.

The early 2000s were a tough time for toy retailers, and competition was fierce from bulk discount sellers like Wal-Mart and Target. Yet in April of 2002, KB Toys’ new owners implemented a dividend recap—a second mortgage of sorts—to pay Bain and several KB Toys executives a special dividend of $120 million.

KB Toys employees and creditors, on the other hand, were about to face some serious financial challenges. In January 2004, KB Toys filed for bankruptcy protection. The new year started off with announcements that at least 30 percent of stores would close and nearly a third of the workforce would lose their jobs. Employees, creditors, and the communities KB Toys served waited to learn where the cuts would take place. In the end, nearly 600 stores closed and 4,000 employees received pink slips. Big Lots, from whom Bain had purchased KB Toys, had to reveal to its shareholders that not only had it not received payment on the $45 million note, but that it was also left holding the bag on store leases that KB Toys defaulted on as it closed stores nationwide. As of the close of 2006, some landlords were still waiting for payment of old rents.

In an action to recover the note and other damages, Big Lots alleged that Bain Capital’s 2002 dividend recap led to the company’s bankruptcy, characterizing the practice as an “unjustified return on [their] investment in excess of … 900 percent in a mere 16 months.” Bain Capital and KB Toys executives cited the difficulty of competing with the discount stores as the cause of the company’s woes. The Delaware state court dismissed Big Lots case, finding that Big Lots was limited to bankruptcy proceedings to enforce this claim.

KB Toys emerged from bankruptcy in 2005 when a new owner—another private equity firm—invested $20 million. For the 4,000 former KB Toys employees who lost their jobs, it was a harsh lesson in the game of private equity buyouts.