Capital Call: Everything You Need to Know

Interest in the world of private equity will at some point expose you to the term “capital call,” a legal maneuver PE managers use to get investors to deliver committed capital. If you plan to pursue such investments, it’s vital that you fully understand what capital calls are and how they work. So, without delay, here’s everything you need to know about capital calls.

Explain Capital Calls

Private equity investors typically don’t put all their capital down at once. At the outset of such investments, just a portion is required. This usually works well for them since they can put that money in an account and earn interest until it’s “called.” Meanwhile, the fund can keep at a minimum the amount of capital it has around that’s not used for investments or to attract new investors with relatively small initial buy-ins.

That’s the broad explanation. Specific terms are presented in the limited partnership agreement that parties sign upon the initial investment.

The Importance of Capital Calls

On a basic level, capital calls keep equity funds going; they are sustenance. They also allow funds to grow and win more investment projects. Remember that most private equity firms function on a just-in-time basis; there’s not a lot of reserves around. So, it’s vital that firms can produce capital when they need to. By definition, “scheduled” investor funding doesn’t permit this.

The Timing of Capital Calls

When are capital calls made? The simple and most direct answer is whenever funds need to. Typically, such calls go out when the firm requires funding for a new project, and even then, only when a deal is nigh. They’re also made in response to unanticipated market challenges, but on a temporary basis.

Calls should not be made to cover operational costs, however, as that’s risky. And besides, capital is meant for growth or more investments. Speaking of risk, fund managers should refrain from making a capital call if they believe it’s probable that the investor in question won’t be able to comply. Doing so could bring about a default and damage to reputations.

The Notice Period

Funds want to skirt planning problems and to remain in good stead with the investor, so managers generally give a notice period of about 10 days.

Capital Calls Content

Each capital call is comprised of the fund’s name, due date, total commitments, payment details, and the percentage of unfunded capital that is called for.

Consequences of Non-Compliance

If there’s one drawback to capital calls, it is risk. Fund documentation is generally insufficient. And as such, investor default can ensue. That situation is the exception rather than the rule, but it does happen. Consequences can include:

• Conversion. Nonpayment could result in the investor’s interest being changed to nonvoting.
• Forfeiture. If the investor defaults, that could result in forfeiture of the investor’s commitment.
• Calling the commitment. A penal rate of interest is applied if the board calls the entire commitment.
• Sale of interest. The investor may be made to sell their interest at a discounted rate to the fund or third parties.
• Withholding against future distributions. Future income distributions will be affected until the capital call is met.
• Lending of the commitment. A fund may decide to lend the contribution via either another investor, a third-party loan, or more capital calls to different investors.

That’s everything you need to know about the ins and outs of capital calls. Just make sure you know what’s in your limited partnership agreement before you sign up. In the interim, if you’re interested in generating secondary income that’s unrelated to the stock market, we suggest you check out the alternative platform Yieldstreet.

Leofric Averille

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