What are the red flags for private equity?

Red Flags in Private Equity: Why Fee Structures Matter

When private equity firms evaluate potential acquisitions, they scrutinize more than just top-line revenue—they look closely at how that revenue is generated. One subtle but significant red flag? Management fees structured as a percentage of collections.

On the surface, tying management fees to revenue might seem like an efficient way to align incentives. After all, if the business grows, everyone benefits. But to experienced buyers, this arrangement raises serious concerns. It often blurs the line between legitimate management compensation and revenue participation—something that can trigger scrutiny from regulators, especially in healthcare-adjacent sectors.

Private equity investors prefer arms-length, market-rate management fees—fixed or formula-based but not directly tied to revenue. Why? Because percentage-based fees tied to collections introduce earnings volatility and can appear to be a backdoor way of sharing in clinical revenue, which may violate anti-kickback statutes or other compliance frameworks.

Buyers also see this structure as a risk to scalability. A fee that scales linearly with revenue can become a growing drag on profitability, making the business less attractive over time. More importantly, it can signal weak operational controls—a hint that the company relies on simplistic financial levers rather than mature, strategic management.

Ultimately, private equity looks for clean, defensible financial models. If management fees resemble profit-sharing rather than compensation for services rendered, it doesn’t just raise eyebrows—it can kill a deal. Sellers looking to attract investment would do well to reevaluate these arrangements long before hitting the due diligence phase.