Tuesday: The legal advice that’s not wanted in the mid-market

Private equity firms are increasingly appointing designated lawyers to work on private debt deals, often well before they have selected which lenders to work with. Once the lender has been chosen, the sponsor assigns its favored law firm to represent the lender on the transaction.

Traditionally, this is a practice only seen in larger deals involving investment banks, where there appears to be some justification for it. As one lawyer told us: “The sponsors designate the lender counsel because bank lenders won’t pay the legal bills but still need some representation. In these deals, the lender is often mandated very late in the process, sometimes not until the day before signing.”

But industry insiders are now seeing the practice extend into the mid-market, where it is arguably less justified, since lenders are usually chosen much earlier in the transaction. What’s more, debt funds find themselves working with law firms that are new and fairly unfamiliar to them. That can make these firms heavily reliant on the sponsors for business – and therefore more likely to put the borrower’s needs first.

“We’re also seeing this manifest itself as a squeeze on legal fees, which isn’t good for the lawyers involved, either,” one GP told us. “This results in a lower quality of service as these firms are operating on very small margins and they’re under pressure to keep the sponsor happy so they can get deals in future.”

The greatest risk for a debt fund in this type of situation is that its lawyer goes soft on terms and fails to fully explain this to the lender.

Today’s newsletter topic comes from our sister publication Private Debt Investor. Click here to read the full article by John Bakie. Watch out for PDI’s July/August issue, which will include a more detailed exploration of this topic.

Private Funds CFO’s Brian Bonilla will be at the Private Debt Investor CFOs & COOs Forum in New York today. The day’s keynote speaker is Marcia Page, founding partner and executive chair of Värde Partners. Drop Brian a line if you’re planning to attend.

Rod James will be at the InvestEurope CFOs Forum in Valencia.