For some firms that rely on monitoring or advisory fees, a struggling portfolio company refusing to pay up can be a serious threat to firm economics.
Portfolio companies pay their private equity owners annual sums for ongoing management and advisory services after acquisition, known as monitoring fees. These arrangements are often structured as five-to-10-year deals or until firms cease to hold a specified level of equity ownership. Some firms require their portfolio companies to pre-pay monitoring fees at the time of acquisition for all or for a significant portion of the term of the management agreement.
A struggling portfolio company refusing to pay monitoring fees can present a severe challenge for firms that rely on them. Such a refusal would represent a breach of contract, but a hard one to enforce, says Eamon Devlin, partner at MJ Hudson: “A GP is unlikely to sue a portfolio company for unpaid monitoring fees as the GP is the equity owner, so putting the creditor into bankruptcy is not a valid option.”
The issue of non-payment of monitoring fees is not currently widespread. However, Devlin adds that for some industries hit hard by the crisis, including travel, leisure and hospitality, that may well change. GPs may also face problems with such portfolios when government aid packages, such as ‘furlough’ schemes, get turned off, thereby placing further pressure on the firms’ economics.