Private equity does not only take a share of the profits. It bills the company. The instrument is a monitoring agreement — also styled a management services agreement or an advisory agreement — signed at closing between the portfolio company and the sponsor. Under it the company pays the sponsor an annual fee for management and consulting services, pays further fees on financings and acquisitions, reimburses the sponsor’s expenses, indemnifies it, and in many versions owes the unpaid balance of the entire term as a lump sum on the day the sponsor exits.
None of this appears in the letter of intent. It sits in the closing set, alongside the shareholders’ agreement, and it is normally presented as boilerplate at a point where the price is already agreed and nobody wants to reopen anything. It is not boilerplate. It is a multi-year payment obligation of the business you still own part of.
What the agreement actually says
These documents are filed. When a sponsor-owned company goes public or issues registered debt, its monitoring agreement is an exhibit, and you can read the clause your own counterparty drafts. KKR’s 2013 monitoring agreement with Renaissance Parent Corp. (later Gardner Denver Holdings) is a clean specimen. The company engaged the manager to provide “management, consulting and financial services”, and in exchange agreed to pay an annual Advisory Fee “in an amount equal to $3,500,000, payable in quarterly installments in arrears at the end of each fiscal quarter”, with the fee set to “increase each fiscal year by 5.0%”.
Four other provisions in the same agreement matter as much as the headline number:
- Transaction fees, on top. The manager may charge “a customary fee” for work “in connection with securing, structuring and negotiating equity and debt financing”, including on any acquisition or divestiture. Every add-on and every refinancing is a separate invoice.
- Expenses. The company reimburses the manager, its affiliates, employees and agents for out-of-pocket expenses, payable within thirty days of a statement.
- Joint and several liability. The obligations are “borne jointly and severally by each member of the Company Group” — the holding company and every operating subsidiary, not just the entity that signed.
- No end date, and no exit from it while the sponsor is in. The agreement continues from year to year unless all parties consent to end it. The company may terminate unilaterally, but only “at any time after the Manager and its affiliates no longer holds any partnership interests” in the sponsor’s aggregator vehicle — that is, only once the sponsor has already gone, and even then the unpaid fees accrued to that date still fall due in cash. For the whole period in which it matters, ending the agreement is not something the company elects.
Two shapes the fee takes
Filings show the fee drafted two ways. Which one you get changes what happens in a bad year.
| Form | Filed example | What it does in a downturn |
|---|---|---|
| Fixed dollar amount with an annual escalator | $3,500,000 a year, rising 5.0% each fiscal year (KKR / Renaissance Parent, 2013) | Nothing. The fee rises on schedule whether earnings rise or not, so it takes a larger share of a smaller number. |
| Percentage of adjusted EBITDA | “an annual monitoring fee equal to 1% of the Company’s annual Adjusted EBITDA (as defined in our credit agreement)” — Biomet, to Blackstone, Goldman Sachs, KKR and TPG | Falls with earnings. But read the parenthesis: the base is the credit agreement’s adjusted figure, not reported EBITDA. |
That parenthesis is the whole negotiation in miniature. A fee pegged to “Adjusted EBITDA as defined in the credit agreement” is pegged to a number built with add-backs that the credit agreement itself permits and caps — run-rate synergies, non-recurring items and, where the agreement allows it, the sponsor’s own fee. Agreeing to a percentage without reading that definition is agreeing to a number you have not seen.
The lump sum at the end
The provision owners miss is acceleration. In 2014 the SEC’s head of examinations described the pattern directly: sponsors had portfolio companies sign “monitoring agreements that obligate them to pay monitoring fees for ten years”, and termination typically involved “the acceleration of all the monitoring fees due for the duration of the contract”. He also named the discount: the acceleration is taken “discounted at the risk-free rate”, and he noted that some of these agreements “run way past the term of the fund; some self-renew annually; and some have an indefinite term”. A ten-year obligation ended at year five does not end. It becomes a bill.
Gardner Denver shows the size of one. Its monitoring agreement terminated on the company’s May 2017 IPO, and under the termination agreement the company paid KKR $16,227,089 — defined as the unpaid fees and expenses accrued to that date, plus the net present value of the fees that would have been payable from the termination date through December 31, 2023.
The SEC has brought cases here, and it is worth being precise about what they were. In October 2015 it charged three Blackstone advisers nearly $39 million — $26.2 million in disgorgement, $2.6 million in interest and a $10 million penalty, with $28.8 million going back to fund investors — for failing to fully inform investors about the benefits they took from accelerated monitoring fees and from discounts on legal fees. In August 2016 four Apollo-affiliated advisers settled for $52.7 million: $37.5 million in disgorgement, $2,727,552 in interest and a $12.5 million penalty. Read what that second figure covers before quoting it: the SEC describes it as a settlement over “fees and a loan agreement and failing to supervise a senior partner who charged personal expenses to the funds”, so accelerated monitoring fees are one of three matters inside it, not the whole of it. What both orders have in common is the disclosure failure — what the adviser told its own limited partners. Neither order says a monitoring fee is improper. The fee is a contract between a sponsor and a company it controls, and the SEC’s interest was in what the sponsor told its investors about it.
Two consequences follow for a selling owner. First, the enforcement regime that exists here protects fund investors, not you. Nobody is required to disclose any of this to a rolling shareholder; your only protection is the document you sign. Second, the Blackstone order notes that some of these payments offset the management fee the fund’s investors pay — a credit that flows to the limited partners, not to your company. If you are told the fee is “offset anyway”, ask who receives the offset.
What it costs an owner who rolls equity: a worked example
The company below is invented and so is the fee. The filings above show the shape of the clause; they are not a market rate for a lower-middle-market business, and no public data set publishes one.
A business earns $6 million of adjusted EBITDA and is bought at 7.0x, a $42 million enterprise value. The sponsor takes 70% and the owner rolls 30% into the new holding company. The monitoring agreement sets a $400,000 annual fee with a 5.0% escalator and a ten-year term. The sponsor sells in year five.
| Period | Fee | Running total |
|---|---|---|
| Years 1–5, paid in cash during the hold | $400,000 rising to $486,203 | $2,210,253 |
| Years 6–10, accelerated at exit (face value) | $510,513 rising to $620,531 | $2,820,905 |
| Years 6–10 discounted to present value at 4% | — | $2,502,043 |
| Total paid to the sponsor by the company | — | $4,712,296 |
| Borne by the 30% rolled stake | — | $1,413,689 |
Two features of that table are worth sitting with. More than half the total arrives in a single line at the exit, in the same wire that pays everybody out, which is exactly when it is least likely to be renegotiated. And the fee is cash leaving a leveraged balance sheet: in a structure where the equity return comes substantially from paying down acquisition debt out of free cash flow, $400,000 a year is $400,000 a year that does not retire principal. Less principal retired means more debt outstanding at the exit, and that lands on the value of the rolled 30% on top of the fee itself.
Run the same arithmetic on your own numbers before you agree to anything. The business valuation calculator will give you the entry enterprise value; the fee schedule is simple arithmetic from there.
What to settle before closing
- Delete or cap the acceleration. This is the single largest line and the easiest to argue: a fee for monitoring services is hard to justify for years in which no services will be provided. If it survives, cap it at a fixed number of years.
- Match the term to the hold. A ten-year term on a five-year fund is a tail, not a term.
- Define the base. If the fee is a percentage, read the EBITDA definition it points at, including whether the sponsor’s own fee is added back before the percentage is applied.
- Cap transaction fees. They are separate from the annual fee and are charged on the events a sponsor controls the timing of.
- Scope expenses and indemnity. “Affiliates, employees and agents” is broader than it looks, and thirty-day payment terms give you no review period.
- Ask where the offset goes. If part of the fee is credited against the fund’s management fee, that credit belongs to the limited partners. It does not reduce what your company pays.
These are governance terms, and they travel with the rest of the governance package: board composition, reserved matters and the consent list. If you are weighing a sponsor deal, the fee clause belongs in the same conversation as the veto rights a minority investor negotiates and the operating changes covered in what happens after private equity buys your company.
Frequently asked questions
Is this the same as the “2 and 20” management fee?
No, and conflating them is the most common mistake. The 2% management fee is paid by the fund’s limited partners to the fund manager. The monitoring fee is paid by your company to the sponsor. Different payer, different contract, and the first does not cancel the second.
Do minority investors charge it too?
They can. The monitoring agreement is a contract with the company, not a function of owning a majority, and it is negotiated at the same closing as everything else. Ask for the draft early in a minority recapitalization, not in the final week.
Will the fee reduce the price I get at close?
Not directly — the enterprise value is agreed before the monitoring agreement is signed. It reduces the value of what you roll, and that is the half of the consideration nobody models.
Can I see what the sponsor charges other companies?
Sometimes. EDGAR full-text search on “monitoring agreement” or “advisory fee” plus the firm’s name will surface filed agreements from any portfolio company that registered securities. It is the cheapest diligence available on a counterparty.
Is the fee tax-deductible to the company?
Treatment depends on facts and on how the services are documented, and it is a question for your tax adviser rather than a general rule. Ask it before closing, because the answer can depend on drafting you can still change.
Sources
- Monitoring Agreement between Renaissance Parent Corp. and Kohlberg Kravis Roberts & Co. L.P., dated July 30, 2013 (Exhibit 10.8 to Gardner Denver Holdings’ Form S-1, SEC EDGAR)
- Termination Agreement between Gardner Denver Holdings, Inc. and Kohlberg Kravis Roberts & Co. L.P., dated May 17, 2017 (Exhibit 10.1, SEC EDGAR)
- Biomet, Inc., Form 8-K filed April 3, 2014 (SEC EDGAR), annual monitoring fee of 1% of adjusted EBITDA
- Andrew J. Bowden, “Spreading Sunshine in Private Equity”, Private Equity International Private Fund Compliance Forum, May 6, 2014
- SEC, “Blackstone Charged With Disclosure Failures”, October 7, 2015
- SEC, “Apollo Charged With Disclosure and Supervisory Failures”, August 23, 2016
The bottom line
A monitoring fee is not a scandal and not a secret. It is a filed, readable, negotiable contract that transfers cash from the company you built to the firm that bought it, every quarter, for as long as the agreement runs — and in many versions, for the years after it stops. The owner who reads it at closing has one evening to react. The owner who asks for the draft alongside the letter of intent has leverage, because the fee clause is one of the few terms a sponsor will move on while the price is still being discussed.
The cleanest version of the question is the one to ask out loud: over the sponsor’s expected hold, what is the total of the annual fee, the transaction fees and the acceleration, and what share of it falls on the equity I am rolling? If nobody will put that number on a page, that is the answer.
There is a structure in which the question does not arise. An Independent Buyout has no financial sponsor, so there is no monitoring agreement, no transaction fee on the next add-on and no acceleration at exit: the company is bought by a trust, the trust holds control, and the existing team carries on running the business. Owners comparing it against a sponsor deal usually start with the pros and cons of selling to private equity. If your company is doing $3M+ in EBITDA and you want to run the arithmetic on both, talk to IBO Advisors.
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