B. Riley-backed Vitamin Shoppe owner files for bankruptcy protection

Franchise Group, the company at the heart of a troubled management buyout that has devastated the stock of B. Riley Financial, has filed for bankruptcy — but plans to keep open most of its retail brands, including Vitamin Shoppe.

The retailer filed for Chapter 11 bankruptcy protection on Sunday, announcing it already had a deal with about 80% of its senior secured lenders that would allow them to convert their debt into ownership stakes and continue operating the businesses.

The company’s chains also include Pet Supplies Plus and Buddy’s Home Furnishings. Its fourth retailer, discount furniture and appliance seller American Freight, will be closed. American Freight operates more than a dozen stores in California, including outlets in Torrance, West Covina and Palmdale.

Franchise Group listed assets and liabilities each of $1 billion to $10 billion. The filing does not apply to franchise-owned stores.

Westwood-based B. Riley took the Delaware, Ohio, company private last year in a $2.8-billion management-led buyout that turned disastrous amid slowing sales for Franchise Group and a scandal involving ties between its founder, Brian Kahn, and Prophecy Asset Management, a hedge fund that federal prosecutors allege defrauded investors of $294 million. Kahn has denied any wrongdoing.

B. Riley took its own 31% stake in the company and took on $600 million in debt to underwrite the deal. It also lent Kahn $200 million over the years to establish Franchise Group and take it private — with most of the loan secured by shares of the retailer. B. Riley founder and co-Chief Executive Bryant Riley has denied knowledge of any wrongdoing, but his firm’s dealings with Kahn are the subject of a Securities and Exchange Commission investigation.

Riley, in a letter Monday to employees, said he felt “personally sick about this result,” which will likely result in a loss of equity stakes in Franchise Group for the company and dozens of B. Riley employees, as well as individual wealth clients and institutional investors.

He added that the downturn in consumer spending and the scandal involving Prophecy could not have been foreseen, but that B. Riley is in “far better shape than folks give us credit for.”

B. Riley has already announced that it would mark down its investment in Franchise Group by up to $370 million and record a loss of up to $475 million when it files its second-quarter earnings, which it has yet to do.

Shares of B. Riley closed down 14% to $4.92 Monday on the Nasdaq. The stock traded at close to $90 three years ago.

Riley told The Times in September that the firm had lowered its debt related to the deal to about $380 million and was carrying $1.9 billion in total debt.

The financial services company has since been selling off assets to continue cutting its debt. Riley, in his letter, said it expects that debt related to the Franchise deal would be lowered to $125 million by the end of the month.

The Franchise Group buyout made B. Riley the most highly shorted stock on the market, meaning investors were betting on the company’s stock price to drop. Marc Cohodes, a leading short-seller in the company, said the bankruptcy filing only underscored how bad a deal it was for B. Riley and other investors it brought in.

“Instead of blaming himself and his crazy deals where he enriched himself at the expense of others, he blames the skeptics,” Cohodes said of Bryant Riley. He added that he doubts the firm can dig itself out of debt.

In September, B. Riley said it had sold a majority stake in its Great American appraisal and liquidation business for about $203 million to Oaktree Capital Management, while retaining a 47% stake valued at roughly $183 million in a new holding company it formed with the L.A. distressed asset manager.

The company also sold off its its interests in a number of apparel brands and the former mall retailer Brookstone for about $236 million.

A few days ago, it said it had sold off a small portion of its wealth management business to Stifel Financial Corp. for up to $35 million in cash. Some 40 to 50 advisors, along with the associated customer accounts, are expected to move to Stifel early next year.