The Private Equity Advantage: Leveraged Buyout Firms and Relationship Banking

Abstract

This paper examines the impact of leveraged buyout firms’ bank relationships on the terms of their syndicated loans. Using a sample of 1,590 loans financing private equity sponsored leveraged buyouts between 1993 and 2005, we find that bank relationships are an important factor in explaining cross-sectional variation in the loan interest rate and covenant structure. Our results indicate that two channels allow leveraged buyouts sponsored by private equity firms to receive favorable loan terms. First, bank relationships formed through repeated interactions reduce inefficiencies from information asymmetry. Second, banks price loans to cross-sell other fee business. These effects are additive. A one standard deviation increase in both bank relationship strength and cross-selling potential is associated with a 17 basis point (5%) decrease in spread and a 0.4 point (7%) increase in the maximum debt to EBITDA covenant. This translates to as much as a 4 percentage point increase in equity return to the leveraged buyout firm.

Keywords: Private equity; leveraged buyouts; bank debt; relationship banking

JEL Classification: G20, G21, G23, G24, G32