Massachusetts-based Staples, Inc., parent of Top 40 distributor Staples Promotional Products (asi/120061), will be on the hook for an additional $130 million in annual debt payments following a dividend recapitalization executed by Sycamore Partners, the private equity firm that owns the company, according to a report from Bloomberg.

On Tuesday, Sycamore executed a $5.4 billion refinancing of Staples, which scored Sycamore a $1 billion dividend. “The dividend is among the biggest in recent memory, even in a world where buyout firms routinely extract large sums for themselves after taking companies private,” wrote Bloomberg reporters Davide Scigliuzzo and Eliza Ronalds-Hannon. Sycamore pulled off a complex deal in January that recouped about $300 million of the equity it put into buying Staples in 2017. The two deals mean the PE firm has now gained back about 80% of the $1.6 billion of its own equity that it poured into purchasing Staples for $6.9 billion. The additional funding for the purchase reportedly came from raising debt against Staples’ wholesale division.

Thanks to one of the largest dividend recaps in recent memory -- and a little-noticed payout earlier this year -- Sycamore has now recovered 80% of the equity it put up for the most promising division of Staples. w/ @ElizaHannonhttps://t.co/CFmUClbmv5 pic.twitter.com/AeQFWwVFHZ

— Davide Scigliuzzo (@dscigliuzzo) April 11, 2019

Despite creditors concerns over terms of Sycamore Partners’ refinancing, which reportedly lacked customary investor protections, banks that included Goldman Sachs Group Inc. convinced investors to purchase the debt. While that was a win for the PE firm, it appears to be a loss for Staples, which now must make “annual coupon payments of almost 11% to buyers of the unsecured bonds, while the senior debt yields around 8%,” Bloomberg reported. “Altogether, the company now faces an additional $130 million annually in interest payments.”

Rich Witaszak, vice president and general manager of Staples Promotional Products, told Counselor that the dividend recapitalization by Sycamore will not impact ad specialty market operations.

Sycamore has a history of retailers it buys going belly up – a result of the retailers being incapable of paying back debt Sycamore loaded them with to fund buyouts, according to reports. Retailer Aeropostale, for instance, accused Sycamore of debt-crushing the firm into bankruptcy as part of a plan to execute a cheap takeover. While the courts scrapped Aeropostale’s claims, Sycamore did bid on Aeropostale in bankruptcy – though ultimately walked away.

The Sycamore/Staples situation is relevant to companies throughout the promotional products industry. As Counselor has previously reported, PE money has been flooding into promo like never before in recent years. As just a sampling: In June 2017, private equity firm H.I.G. Capital acquired Top 40 supplier BIC Graphic (asi/40480) for a reported $80 million. A year later, TPG Growth purchased Top 40 distributor HALO Branded Solutions (asi/356000) from another private equity firm for an undisclosed amount. In August, Blue Point Capital Partners, a Cleveland-based private equity firm, recapitalized Top 40 supplier Next Level Apparel (asi/73867). 

What’s more, private equity remains keen on the ad specialty industry, meaning the investment is likely to continue. “The PE market is waking up to the underlying attractions in the promotional products sector – market growth, buy and build opportunities, efficiency opportunities, globalization, further penetration of corporate accounts, etc.,” said David Colclough, a partner with U.K.-based Elysian Capital, whose promo investments include large U.K. distributor Brand Addition (asi/202515) and Facilisgroup, an U.S.-based ad specialty partnering and technology organization. “It’s a great sector to invest in with long-term positive growth drivers and opportunities.”

Given PE’s ramped up interest, it’s essential that distributors and suppliers alike recognize the potential positives and negatives of private equity partnership. Promo firms connected with what they characterize as ethical private equity outfits that have the companies’ interests at heart say their partners provide investment power, business insight and operational expertise that’s helping to drive efficiencies and growth in sales and profitability. 

Still, only the naive would think that PE money is always about the best interests of businesses it acquires, say some industry sources. “The true model of these firms is to turn a profit and flip the companies they invest in every three to seven years,” said Memo Kahan, president of Top 40 distributor PromoShop (asi/300446), which is not PE-backed. “It’s alright when business and the economy are going good, but if that changes, I worry that a lot of people are going to lose their companies.”

Joshua White, general counsel and SVP of strategic partnerships at Top 40 distributor BAMKO (asi/131431), expressed a similar view about the potential perils of private equity. “The problem with private equity is that the incentives are not properly aligned,” White told Counselor. “The objective of private equity is the extraction of maximal value in the shortest time frame possible. Each of those two concepts -- value extraction and an expedited time frame -- presents a potential moral hazard that can seriously jeopardize the long-term well-being of a company.”

Thus, promotional products firms considering private equity investment must take pains to partner wisely. Here are eight rudimentary tips to help get you started on finding a quality PE partner.

1. Ensure potential partners understand your business and the promotional products industry.
2. Beyond capital, a good PE firm will bring expertise that should help your business run better. Before committing, thoroughly understand the firm’s capabilities/services for assisting you on strategy, technology, finances, management, various operations, networking and more.
3. Learn if a potential partner has previously invested in promo products or a related industry. How did the relationship go? Were there difficulties? If so, how did the situation play out?
4. Investigate the potential partner’s overall track record. How well does the PE firm support its investments? How did the businesses do under the firm’s management?
5. Make certain your goals and objectives align.
6. Personality conflicts can complicate any business partnership. Ensure management level personalities mesh.
7. Understand the PE firm’s investment horizon for your company.
8. Know what transactional and management fees the firm might charge.