Capital Calls: how we call our investors’ capital
How do venture firms call their capital? This is an important question to understand for both entrepreneurs looking for venture capital as well as investors interested in investing in a venture capital fund.
When we tell people that we manage a 50M dollar fund, some imagine a bank account with 50M dollars just sitting there. That we would great, but it is far from the truth. What we actually have is 50M dollars of committed capital: these are legal documents which state that our investors are promising to send us that capital when we ask for it (or when we “call” the capital, hence “capital call”).
The reason behind this is simple: we don’t need the money right away. We usually take 4 years to deploy the total fund amount, so we call the capital over a 4 year period. On top of that, we offer our investors a preferred return before we start to start to split the profits (through carried interest, explained in this post https://link.medium.com/ZSC9o4NgH1). If we would ask for all of the money upfront, the money would be sitting idle without generating any profits, but would be generating a negative return for us because of the preference we offer. It wouldn’t make any sense at all.
So what actually happens is that we source opportunities, analyze them and once we have decided that we want to invest (and the founders have agreed to our term and conditions), we sign the legal documents and then call the capital. We send out a letter to our LPs saying: “we have decided to invest in X company and we are investing Y% of the fund, please send us Y% of your commitment.” These investors send the money to our investment vehicle and it is immediately sent to the company we invested in. We usually give our LPs a 15 day period to invest.
As a founder looking for venture capital, it is important for you to understand this so that you are aware of timing with regards to funding from your investor’s LPs. It is important to understand how your investors call their capital, what are their time expectations for funding, who their LPs are and what certainty of funding they have. It is also important for LPs to understand so they know that they do not need to deposit the commitment immediately, they will be depositing over a 4 year period. Also, so they can plan their cash flow accordingly in order to invest and deposit on time. The timing of deposits is extremely important for founder’s plans and so it is equally important for VC funds to realize those deposits on time and this depends, directly, on the discipline of their LPs.
So, if you are raising money from VCs for your business, make sure to understand their timing and how they call their capital. If you are interested in investing in a venture fund, make sure you understand the timing behind your commitments. If you are an investor in a VC fund, be very disciplined with your deposits: the entrepreneurs we are investing in depend on you.