What Is a Capital Call?

Unlike traditional investments like mutual funds, where investors pay the full amount upfront, private equity and venture capital funds follow a different approach. 

Limited partners (LPs) commit a specific amount of capital but do not transfer it immediately. Instead, the general partner (GP) requests portions of the committed capital through capital calls as needed for investments or expenses.

What is a capital call?

A capital call occurs when a private equity or venture capital fund requests its investors (LPs) to send part of the money they previously agreed to invest. 

This typically happens when the GP identifies a new investment opportunity, requires follow-on funding for an existing investment, or needs to cover the fund's operational expenses.

The GPs usually send a formal capital call notice to the LPs, specifying the amount required, the deadline for payment and the opportunity. 

When a capital call is made, LPs are obligated to provide the capital they pledged at the start of the agreement, typically within a set period, ensuring the fund is properly capitalized.

How do capital calls work?

Venture capital firms operate under a general partner (GP) and limited partner (LP) structure. While the GP manages the fund’s investments, most of the capital comes from external investors (LPs), who commit to providing funds but don’t transfer the full amount upfront.

When a VC raises a fund, it secures capital commitments from LPs. These commitments are legally binding promises to contribute money when requested, rather than lump-sum payments made at the time of commitment. 

This structure allows LPs to manage their capital more efficiently while ensuring the VC firm can access funds as needed.

Each LP’s commitment is documented in subscription agreements, including the Limited Partnership Agreement (LPA). 

This document outlines key details such as:

• Total committed capital of the LP
• Rules for capital calls, including timelines and penalties for non-payment
• Management fees the GP collects for operating the fund
• Profit distribution terms when investments generate returns

LPs may also have side letters, which modify specific terms on a case-by-case basis.

Venture funds typically have a 10-year lifespan, with an initial investment period that spans multiple years. LPs prefer to keep control of their capital until the VC actually needs it. This allows them to invest in short-term opportunities and maximize returns on uncalled capital.

Capital call example

A venture capital firm, XYZ Ventures, raises a $100 million fund. Instead of collecting the entire amount upfront, XYZ Ventures secures capital commitments from their LPs.

Each LP agrees to contribute a specific amount, but they don’t transfer the funds immediately. Instead, their commitments are legally recorded in the Limited Partnership Agreement (LPA).

A year later, XYZ Ventures finds a promising startup and needs $20 million to invest. The GP issues a capital call notice to all LPs, requesting funds proportionate to their commitments. For example, if an LP committed $10 million (or 10% of the total fund), they must contribute $2 million (10% of the current call).

LPs have a set period to transfer the requested amounts. Failure to meet the deadline may result in penalties, such as interest charges or dilution of their fund ownership.

XYZ Ventures invests the $20 million in the startup and continues managing the fund. Over the next few years, it issues additional capital calls until the full $100 million commitment is utilized.

How capital calls affect key fund metrics

Capital calls directly impact several fund performance metrics, influencing how investors assess the fund’s financial health and efficiency. Here’s how:

1. Influence on internal rate of return (IRR)

IRR measures an investment’s profitability by considering both the timing and size of cash flows. Capital calls must be carefully timed. If made too early, funds sit idle, reducing IRR and if made too late, investment opportunities may be missed, lowering returns. Balancing capital calls effectively helps optimize IRR.

2. Effect on total value to paid-in (TVPI)

When a fund calls capital from investors, it lowers TVPI (Total Value to Paid-In Capital) at first because the money is being invested, but the investments haven't grown in value yet. As time passes and the fund successfully sells investments for a profit, TVPI increases, showing higher returns for investors. Well-managed capital calls ensure funds are available when needed, optimizing TVPI. If poorly timed,  they can lead to missed opportunities or inefficient capital deployment, ultimately dragging down TVPI. 

FAQs

1. Can a limited partner refuse a capital call?

In most cases, a limited partner (LP) cannot refuse a capital call if the commitment has been made in the Limited Partnership Agreement (LPA). The LPA typically outlines the consequences of non-payment, such as penalties, dilution of equity, or the loss of rights within the fund. Refusing to meet a capital call can result in significant financial and legal repercussions for the LP.

2. What is the typical timeline to fulfill a capital call?

The timeline to fulfill a capital call is usually specified in the Limited Partnership Agreement (LPA) and typically ranges from 10 to 14 days. Limited partners (LPs) are generally given sufficient time to fulfill the capital call, but the exact period can vary based on the urgency of the investment opportunity and the fund’s operating terms.

3. Can LPs adjust their capital commitment after a capital call?

Once a capital commitment is made, it is generally binding, and LPs cannot adjust it after a capital call has been issued. Any changes to the commitment would typically require mutual agreement between the LP and the general partner (GP) and would be subject to the terms outlined in the Limited Partnership Agreement (LPA).