Updated October 2, 2020:

What Is a Capital Call?

Capital calls are used to secure short-term funding on projects within private equity funds in order to cover the time between the financing agreement and the money received. It is a solution that is generally in place for 30-90 days. 90 days after the capital call, notice is given to the investors. Capital calls are generally sent via registered mail, but some funds use email, which is also acceptable. 

Capital calls are considered to be short-term loans, ensuring the liquidity of the equity funds and securing ongoing revolving investment projects. Capital calls are secured against the fund's pledges for capital contributions, unfunded investor commitments, or granted by the fund through power of attorney. Capital calls need to be clear, easy to understand, and include all the information needed for making a transfer. They must include a deadline, amount, and the name of the investor/fund.

Capital calls are generally used by real estate funds. However, an increasing number of private equity funds are using the option to secure funding and liquidity and manage investments short term, as well as private banking funds. They are usually used when the fund reaches beyond its funding sources and needs to secure investment for expansion, continuing a project, or buying assets. 

Capital Call: When Should It Be Used?

Capital calls are used when the fund is in need of capital, and the bridging funding for the short period is secured against the partners' or investors' capital commitments. It is short-term borrowing that makes the day-to-day management and funding of private equity firms easier. 

Capital calls are usually made on an as-needed basis, so they are not dependent on the schedule of funding by partners. Capital calls are also known as securities loans. Fund managers send out capital notices when they are ready to sign an investment deal. 

The notice period of capital calls is generally more than seven days, to avoid planning problems. Instead of asking investors to reschedule their capital commitments, the fund applies short-term borrowing to secure investments in companies and ventures. It also uses the future investment of partners as a form of security. Capital calls are also referred to as drawdowns. 

The main challenges related to capital calls are deficient fund documentation, which makes it hard to make capital calls, and sovereign immunity issues. 

The information that needs to be included in capital calls are:

  • Percentage of unfunded capital called for
  • Payment details 
  • Name of the fund
  • Due date
  • List of total commitments

Why Is a Capital Call Important?

Capital calls are important because they secure funding for ongoing or new investments and guarantee the growth of private equity funds. Many equity firms work on a just-in-time basis, so they require immediate investment that is not possible through investor funding if it is already scheduled. This is why they issue capital call notices. 

Capital calls facilitate the purchase of investments for funds and secure the liquidity and growth of the venture capital or private equity funds. All private investment funds and joint venture agreements have a closure on the right to capital calls. When changing financing requirements challenge the liquidity of the fund, capital calls can guarantee continuous operation and growth. 

In most funds, around 25 to 50 percent of the final investment is kept as a security and scheduled for a later date. Through capital calls, investments can be spread out to later dates and issued at the times when they are needed by the fund to secure opportunities and manage challenges. The capital call amount is limited by the unfunded capital commitments of the investors.

It is important that managers carefully consider the default provisions in the fund agreement so they can secure the funding immediately to cover ongoing investments. The main purpose of default provisions is to deter investors from defaulting on their commitments. The most commonly used default provisions are:

  • Forfeiture: The  forfeiture remedy cause defines sanctions against the investor that forfeits their commitment
  • Conversion: The interest of the defaulting investor could be converted into nonvoting as a result of nonpayment
  • Calling the entire commitment: A penal rate of interest is applied when the board calls for the entire commitment
  • Sale of interest: The investor might need to sell his interest at a discounted rate either to third parties or the fund
  • Withholding against future distributions: Future income distributions will be affected until the unpaid capital call of the defaulting investor is paid
  • Loaning of the commitment: There are three ways a fund manager might loan the contribution: allow a non-defaulting investor to loan it, secure third-party loans, or issue further capital calls for the rest of the investors

Examples: Using Capital Call

There are several reasons why private equity or real estate funds might decide to use capital calls:

  • Satisfying changing financing requirements
  • Investment projects that go over budget
  • When the occupancy of the real estate fund drops, increased funding is needed for short term 
  • Dealing with an undercapitalized fund
  • Continuing with an investment project despite increasing costs
  • Lack of liquidity due to client collection problems
  • Banks or financiers ask the fund to make a capital call to secure financial agreements

Examples: Not Using Capital Call

There are some common reasons why some private equity and real estate funds decide not to use capital call. One of the main reasons is because of the risks associated with the option. In some cases, investors might not be able to comply with the request, resulting in a default and the loss of reputation. 

Subscription capital calls are not the right option for funds that want to appear stable for further investors. Generally, funds that use capital call are considered to be less liquid than those that do not use them. 

Not using capital calls and scheduled contributions of investment reduces the fund's flexibility to deal with unexpected market changes and challenges. 

If you are not sure whether or not you should issue a capital call, consult with an expert private investment funds practice attorney. 

Frequently Asked Questions

  • When are capital calls issued? 

Capital calls are generally issued when an investment deal is about to close. The fund manager needs to adhere to the agreement that states the number of days' notice needed to make a capital call. For most funds, the notice period is 10 days. 

  • What is the main benefit of capital calls? 

They provide the fund with liquidity and flexibility, continuous funding, and a solution to bridge the gap between calling for funding and receiving contributions through financing. 

  • Who provides the securities loans for real estate and private equity firms? 

Private and commercial banking companies provide bridging loans secured against unfunded commitments of investors for short-term periods.

  • What happens if an investor does not comply with the capital call? 

Based on the investment agreement and schedule, the fund manager can ask for release of the entire commitment, or declare forfeiture or default. In the worst case scenario, the manager can push the investor to sell their interest. In some special circumstances, other equity fund members can provide a short-term loan for the investor that cannot comply with the request.

Common Mistakes

  • Making a capital call too early without a deal can cause unnecessary overfunding of the real estate equity fund. Capital calls should only be issued when there is an investment opportunity in place. 
  • Relying on capital calls to cover the cost of operation is not good, as the equity fund's main purpose is to create value and profit for investors. This option should only be used to fund investments and deal with unexpected market challenges on a temporary basis. 

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