A capital call is a process of conducting fundraising in which company management commits to giving a portion of the company’s control to investors, but also asks investors to contribute a certain part of its obligations to the foundation. A capital contribution requirement is often used during this process. This is a legally binding requirement to abide by the regulations set forth in the limited partnership agreement. This call obligates investors to issue capital to the company as soon as it requires it. In this article, we will take a closer look at the concept of a capital call.
What is a capital call?
In other words, a capital call can be described as near-term financing that is done by a PE fund and usually occurs when the fund needs to cover charges or make new investments. Capital calls are divided into endowment capital and paid-in capital, but what do they mean?
Allocated capital is the whole amount of investment that your partners are committed to paying into the fund. So, let’s say if you have an agreement with investors to invest a certain amount in your company, it doesn’t mean that you get it right away. It means that the partners are obliged to pay out the sum at a time during the life of the contract. At the beginning of the fund’s existence, investors put some part of the money there, which can be very different, depending on your need for that money and the investors’ preferences.
Paid-up capital is the money your partner has already invested in the fund. There is a difference between allocated and paid-up capital, which is called uncommitted capital, that is, the amount that LPs plan to pay out in the future. Accordingly, capital calls are how the company turns uncommitted capital into paid-up capital.
Capital Call Requirements
All capital call requirements are generally described in the limited partnership agreement, and typically include the following:
- LP is obligated to pay the capital call within 10-20 days of receipt of notice
- There is a fixed amount that the company can claim over a period of time
- Time of deployment of the fund during which LPs must pay all of their investments, usually the fund exists for 2 or 3 years
- Limits on capital calls are prescribed, once the capital is deployed
- Set penalties in case investors fail to meet your capital calls
Capital Call: when should it be used?
Once we’ve figured out what is a capital call in private equity, you also need to know when it should be used. Capital calls are applied when an investment fund needs money and short-term bridge financing is backed by capital obligations of associates or investors. It is shorthand borrowing that makes the routine administration and the financing of PE companies simplified.
Capital calls and distributions can occur whenever you want, without relying on a fixed schedule of ongoing investments. Often, these capital calls are called securities loans. Fund administrators request a capital call when they are about to underwrite an investment transaction.
The notification interval for capital requests typically goes beyond seven days to prevent planning issues. Rather than asking partners to reconsider their equity commitments, the fund leverages near-term debt to provide investments in companies and ventures. It likewise utilizes future investments by partners by way of a form of security. Capital calls are also referred to as drawdowns.
The major issues with capital appeals are insufficient fund records, which complicate capital requirements, and issues of proprietary immunity.