Private equity managers make this call whenever they need to collect the balance of committed funds from investors. If you’re planning to enter PE or venture capital, it would behoove you to learn the ins and outs of this legal tool sooner rather than later. So, how does a capital call work? Keep reading.
Just What is a Capital Call?
It’s a process wherein a fund manager asks fund investors for the rest of their fund commitment as set out in the fund’s limited partnership agreement (LPA), which you must sign from the outset.
Typically, private equity investors contribute just a portion of their commitment initially. For example, say you agreed to commit $150,000 to the fund, but put up $50,000. At some point – you don’t know when so you must have the funds handy – you’re going to be “called” by the fund manager for the $100,000.
What’s in a Capital Call Notice?
While there’s no formal template per se, an investor, also known as a limited partner, can expect such a notice to include the amount due, the due date, the total amount committed, and banking details.
What’s in a Limited Partnership Agreement?
An LPA typically includes information such as how fast the balance must be forthcoming as well as how much the fund manager — also known as the general partner — can demand through capital calls overall during a certain period.
The agreement also usually includes the period during which the fund will make all investments, as well as information about any restrictions on the volume of calls after that period ends. Moreover, the LPA typically spells out the consequences of failing to meet the capital call, as well as remedies.
How Long Do Investors Have to Pay?
Once a call is made, limited partners typically have between 10 and 20 days to send over the cash.
When are Capital Calls Issued?
Let’s be clear: a capital call is issued whenever a fund needs a cash infusion. Typically, that’s when a project deal is near. However, the timing can also be more nuanced.
For instance, the general partner might not want to make a call if they know an investor isn’t ready. If the fund can get by for a bit, there’s little reason to embarrass the limited partner and sully their reputation, or to strain the relationship.
What Do Capital Calls Offer?
In the main, capital calls keep private funds going – and growing. Funds need investments to thrive.
Also, funds don’t like to have excessive capital around that isn’t being invested or used to lure other investors with low front-end buy-ins. So, partial payments work for them. They also generally work for investors, who get to hold onto some of their commitment and maybe even make some money by putting the balance in a low-risk account.
How Do Capital Calls Work?
There may be a scenario in which an investor pledges $100,000 to a $100 million fund. The investor is permitted to contribute $30,000 upfront and hang onto the $70,000 for the time being. In the interim, the fund invests the $30 million it gets from all limited partners in multiple startups.
Six months later, the fund seeks an additional $20 million. The investor must then send $20,000 of their committed $100,000, leaving them with a $50,000 balance. The process continues until the general partner has fulfilled their fund commitment.
Now you know how capital calls work. And that’s a good thing, since knowing the ins and outs of capital calls is an integral part of private equity investing. You’re well on your way to gaining the knowledge necessary to join a fund and begin reaping rewards. But it is crucial to keep learning.