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

We find that a private equity (PE) sponsor's relationship with the law firm that advises banks (i.e., lender law firm) leads to weakened creditor protection in leveraged buyouts. When the PE-Lender Law Firm relationship is stronger, buyout loans are less likely to have a dividend payout restriction and have fewer covenants overall. This finding is robust using PE-Lender Law Firm geographic distance as an instrument for PE-Lender Law Firm relationship. Lead banks that use PE sponsors' relationship law firms are more likely to be included in the lending syndicate of next buyout deal of the sponsor. Loans with stronger PE-Lender Law Firm relationships experience weaker loan investor demand in the primary market and higher likelihood of subsequent defaults. Taken together, our paper uncovers PE sponsors' relationship with banks' legal counsel as an important channel through which PE sponsors exert bargaining power in buyout loan contract negotiations and provides new perspective to the debate on the controversial role of PE sponsors.