Private Equity Sponsors, Law Firm Relationship, and Loan Contracts in Leveraged Buyouts

We study how private equity (PE) sponsors influence leveraged buyout (LBO) loan contracting through their relationships with bank’s legal counsel (“lender law firm”). We show that stronger PE–Lender Law Firm relationships are associated with fewer loan covenants. This result is robust when we instrument for the relationship using geographic distance between PE sponsors and law firms. Loans involving relationship lender law firm also feature higher default rates and higher interest spread. Lead banks that use a sponsor’s relationship law firm are more likely to receive future deal mandate from the sponsor. Overall, we highlight PE sponsors’ ties to lender law firms as an important channel of PE bargaining power in buyout financing. Our findings also raise concerns that lead banks, competing for deal mandate and operating under an originate-to-distribute model, may have weakened incentives to insist on stringent negotiation.