You may have heard of capital calls, those legal acts performed by private equity (PE) funds to collect capital committed by investors. But within “capital call” are other terms with which you should be familiar — particularly if you plan to enter the world of PE or venture capital — terms such as “committed capital” and “active contribution.” Let’s look at terms you’ll encounter with a capital call – and more.
Can You Explain Capital Call?
A capital call is a business maneuver fund managers use to collect the balance of their commitment whenever they need money, which is usually when they’re about to seal the deal on a project. We say collect the commitment’s “balance” because investors are not usually required to submit their entire pledge at once.
Investors know the call is coming; they just don’t know when.
What’s in a Capital Call?
Details are unique to each firm and are spelled out in the limited partnership agreement that investors sign when they make their initial investment. However, such a call will generally contain:
- How soon the payment is due after notice is received (it’s typically between 10 to 20 days).
- The most a fund can collect from all capital calls from all investors during a certain period.
- The period during which the fund will make all its investments. The “deployment period” is usually the funds first two or three years.
- Any restrictions on calling capital after the end of the deployment period.
- What happens if there’s a commitment default. After giving the investor an opportunity to make amends, and things still don’t work out, such penalties can include charging interest on the amount the investor didn’t honor and limiting the share of future distributions.
What are the Advantages of Capital Calls?
There are advantages for investors as well as funds. For funds, the top benefits of a capital call are:
- Growth promotion. Let’s face it: funds need cash to exist … and grow. Indirectly, that helps other funds get started.
- Better performance by two top fund performance metrics: internal rate of return and total value to paid-in capital.
- Helps to bring in cash. Capital call funds can be used to offer low initial drawdown to lure investors to the fund.
For investors, key benefits include:
- No need to invest all capital at once. This takes some of the pressure off investors, who can put the balance away, in a low-risk account for example, for safe keeping, and perhaps even make some money.
- The ability to use distributions for commitments. If your fund pays distributions to investors before calling all their committed capital, investors can use the distributions to pay commitments.
Terms Used in Capital Call
We’ve already described a few terms in the writing of this article, but some terms you’ll encounter include:
- Committed capital. It’s the amount of money an investor has pledged to contribute to an investment fund.
- Paid-in capital. This is an investor’s total committed amount.
- Uncalled capital. This is the difference between paid-in capital and committed capital.
- General partner. Another term for private fund managers.
- Limited partner. This is another term for investors.
- Limited partnership agreement. This is the document signed by the investor that details the terms of your agreement with the fund.
- Capital call notice. This is the notice that’s sent to investors to inform them that a capital call is coming.
- Capital call payment. This is any payment an investor makes related tp a capital call.
So, you now know some of the essential terms you’ll encounter with a capital call, plus important info about the call itself. It’s essential that you understand on the front end everything you can about what such calls are as well as how they work. If you need more information, we suggest that you take a look at the alternative investment platform Yieldstreet.