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What are capital calls in VC?
A capital call, also known as a drawdown, is a formal notice from a private investment fund (like a private equity fund or a venture capital fund) to its investors (usually referred to as limited partners or LPs) asking them to send a portion of the capital they committed to invest in the fund.
When an investor agrees to participate in a fund, they sign a commitment to provide a certain amount of capital to the fund. However, the fund manager doesn't typically require all of this capital upfront. Instead, they call for or "draw down" the capital as needed for investments and expenses.
When the fund manager identifies an investment opportunity or needs to cover operating expenses, they issue a capital call to the limited partners. This notice provides details such as the amount of capital required, the purpose of the drawdown, and the deadline by which the capital must be transferred.
Capital calls are a standard part of the operation of private investment funds and are used to ensure that the fund has the necessary capital available when investment opportunities arise, without requiring investors to transfer all of their committed capital upfront.
How do capital calls work in VC?
In Venture Capital, capital calls typically consist of four main line items, each serving a specific purpose within the fund's lifecycle.
The most common line item is Working Capital, which refers to the money used for investments. This capital is called as needed and is paid by the investors pro rata to their commitments.
Throughout the fund's formation and its lifetime, it incurs various legal and administrative fees. To cover these costs, Expenses are called as a separate line item. Similar to Working Capital, Expenses are called pro rata. However, Expenses can be capped at the fund level to manage costs effectively.
In addition to these ad hoc line items, the Management Fee is called from the LPs at a consistent frequency, most often quarterly. Unlike the Working Capital and Expenses, the Management Fee is typically not called pro rata to the LPs' commitments. Instead, it is calculated as a fixed percentage of each LP's commitment per year, which can differ from LP to LP and usually ranges between 1% and 3%.
To balance rights and obligations among LPs, especially those joining in a later closing of the fund, Equalisation Payments are called. These payments are calculated by recalculating each previous capital call for each LP based on their updated ownership share in the new closing. The difference is returned to the "old" LPs and called from the "new" LPs, effectively adjusting the pro rata shares of previous capital calls. Additionally, new LPs often pay Equalisation Interest to existing LPs, typically calculated using a fixed percentage from the due date of the equalised capital call to the due date of the current capital call.
Similarly, new LPs are required to pay the Management Fee Catch-up for the period before they join. This payment is made directly to the fund and, unlike equalisation payments, is not distributed to existing LPs. There is often, but not always, a Management Fee Catch-up Interest calculated in the same manner as the equalisation interest.
Complexities of capital calls in VC
Precise calculations
Legal requirements, such as Equalisation Interest Payments that are calculated on a daily basis or Management Fee Step-Downs, lead to complex calculations being necessary. After each Closing, each previous capital call needs to be recalculated for every investor, taking into account their unique circumstances such as differing management fees or exemptions from certain investments. This process can become highly complicated, especially when dealing with a large number of investors and multiple capital calls. In extreme cases, the calculations might require excel sheets with 10+ columns for each previous capital call and one row for each investor. This could result in a data set of 100 rows by 100 columns for a fund with 10 capital calls and 100 limited partners (LPs).
Understanding the Legal Foundation
The calculations for capital calls are defined and governed by various complex and fragmented legal documents, including the Limited Partnership Agreement (LPA) and side letters. As a result, Fund Administrators must continually refer back to these legal documents with each capital call to ensure all edge cases are considered and the calculations are legally sound. However, this process is inherently cumbersome, often leading to oversights and capital calls calculated on shaky legal foundations. The obvious need for attention to detail can result in errors and inefficiencies, highlighting the importance of streamlined and accurate legal interpretation in the capital call process.
Importance of Data for Downstream Processes
Capital call data is incredibly important for downstream processes, such as maintaining accurate capital accounts or calculating future capital calls. However, the calculations for historical capital calls are typically stored in Excel files, and their structure can vary significantly from one capital call to the next. This variability complicates the reconciliation of payments and the management of capital accounts over the fund's lifetime.
As each capital call is unique, the reconciliations and downstream processes become increasingly complex. This exponentially increases the effort needed to create future capital calls or generate accurate fund reporting.
LP Relationship Management
Capital calls are one of the most important aspects of the relationship between General Partners (GPs) and Limited Partners (LPs) during the investment period. To maintain a strong and positive relationship, capital calls should always be as LP-friendly as possible. This means ensuring that the process is smooth, transparent, and considerate of LPs' convenience and preferences.
For instance, minor returns of capital contributions should not be paid out, and capital calls of less than $1,000 should generally be avoided. These practices help to minimise administrative burdens and maintain LP satisfaction. By optimising the capital call process to be more considerate of LPs' needs, GPs can foster a stronger, more trusting relationship with their investors.
Capital Calls at bunch
Instead of scattering your fund's data across legal documents, Excel files, and drawdown PDFs, bunch consolidates everything into one central source of truth and executes automated end-to-end processes on top of this data.
With bunch, each capital call is calculated based on the actual legal conditions defined in the LPA and side letters, stored in one format and location, and directly integrated into the calculations for subsequent capital calls and quarterly reports.
Our Capital Call Assistant significantly reduces the effort needed to create capital call calculations. Instead of manually reading through legal documents and drafting Excel files from scratch, you as the GP can create a capital call with the click of a button. Simply specify the amount you want to call and the purpose of the funds. After the calculations are automatically generated, you can review them and download an Excel export of the underlying calculations. Once you have reviewed and confirmed the calculations, the notices for each investor are automatically created and ready to go.
Notices are securely distributed via tasks on our platform, enabling automatic tracking of incoming payments. This progress tracking feature provides you with a clear and up-to-date view of the payment status, ensuring a seamless and efficient capital call process.
