A capital call (also referred to as a ‘drawdown’ or a ‘capital commitment’) is the means by which limited partners fund their investments in a private equity fund.
An LP agrees to a certain capital commitment as part of their Limited Partnership Agreement (LPA) with a private equity fund. General partners of private equity funds, however, are typically not able to make all of the fund’s intended investments at once, so they will notify the LPs when investments are about to be made and request a portion of the LP’s commitment to be delivered.
The means by which a GP requests investment capital from LPs is the capital call. It often takes several capital calls over the course of months or even years for investors to become fully invested in a PE fund. The terms on precisely how and when to comply with a capital call are detailed in the LPA.
An exception to capital calls occurs with ‘co-investment’ opportunities, where LPs can invest additional capital alongside the fund as a separate investment. Co-investments will usually require capital from the LP at the time of the investment commitment.
GPs generally need time to identify and acquire all the target assets for a PE fund, causing the timing of investments to be unpredictable. Rather than take an investor’s entire commitment up front and have some or all of it sit idle until target investments are identified, GPs use capital calls to allow investors to hold on to their capital until such assets have been identified.
Capital calls also enable the GP to adapt their strategy to market conditions and the necessary time to identify opportunistic target investments without undue pressure to put investor money to use right away or dilute their returns by having capital parked in liquid accounts earning little return.
In some situations, a GP may borrow funds from a bank via a ‘bridge loan’ to acquire a target asset. Bridge loans are temporary measures to facilitate a deal and capital calls are then issued later to pay off the loans.
To make the most effective use of capital and keep borrowing costs low, capital calls are typically issued once an investment deal has been identified and the GP is ready to close on it for the fund. Investors are usually given around 10 days or so from receipt of a capital call to transfer their money to the fund.
An example of how capital calls might work is shown in the table below.
Investor Commitment: $100,000
Moonfare’s unique ‘feeder fund’ structure aggregates capital from numerous individual investors to meet the high minimum investments imposed by most private equity GPs. In this manner Moonfare enables investors to participate in private equity funds with much lower minimum investment commitments.
To defray the cost of setting up the feeder funds and to provide the capital for initial PE fund purchases, Moonfare asks for an initial deposit of 25% of an investor’s total commitment upon signing the investor agreement.
Thereafter, capital calls are made in accordance with the PE fund’s schedule. Upon notification of a capital call from the fund’s GP, Moonfare immediately notifies investors in writing as well as through their online platform, providing them with 7-10 days’ notice to meet the call. Investors manage the entire process digitally.
Understanding capital calls and how they work is essential to investors in private equity funds. Capital calls provide advantages to both GPs and LPs in terms of cash flow and maximising returns. They are, however, a contractual obligation between the investors and the funds.
GPs make capital calls as needed to fund their investments during the investment phase of a fund, which can be up to 5-7 years. Capital calls are issued as needed to buy target assets and can therefore occur at irregular intervals.
Investors are notified of capital calls in writing with 7-10 days to comply. They can also monitor their capital calls through Moonfare’s online platform.
The consequences for defaulting on a capital call are explained in the Investor Agreement associated with each fund and can include loss of equity and rights in the fund, interest charges, sale of the investor’s stake to third parties.
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