When a VC fund is raised, not all the money is collected immediately from the Limited Partners (LPs). From time to time or as agreed by both parties (VCs and LPs), a capital call will be raised for the disbursement of part of the fund. This article discusses these in detail.
Definition of Capital Call
It is a demand notice from a VC firm to its general partners to provide part of the committed fund required for an investment deal.
It can also be referred to as a legal right or request from the VC firm to investors for a portion of the fund already committed for an already established investment deal.
It is a demand notice. The notice is usually within 7 days or at most 10 days. The investors, that is, the LPs are required to make the fund available within that period. If a limited partner defaults in payment, the VC will have to make provision for it. The provisions are discussed in another subheading.
The capital committed in the agreement between both parties is not paid in full by the limited partners. The arrangement made provisions for several capital calls to be made by the general partners.
A legal request or right. It is also a legal right on the part of the VC firm. This implies that the General Partners do not have a choice than to pay up the capital call. It also means that the drawdown is legally binding on both parties.
Committed fund. Or capital commitment is the total amount that has been agreed on by both parties as the VC fund. Upon such agreement, the LPs will make part payment. For example, let’s say the total capital commitment is 100 million Naira. And the LPs paid 20 million Naira on Application and Allotment of the fund. When an investment deal for say 15 million Naira has been concluded by the VC firm with a private equity company, it may request a takedown of that sum to close the deal.
Investment deal. Venture capital firms find potential growth private equity companies to invest. On reaching an investment deal, it will request a call from its investors to close the deal.
Please, note that, the term discussed in this article was coined from real estate companies and it is also used by insurance companies. And when the takedown amount is fully paid it is called paid up capital.
Provisions for Default in payment of Capital Call
A danger of call is the failure by one or more general partners to make payments on call. To protect the fund and as well to meet up with the investment deal, the VC firm makes provisions for default drawdown. Below are some of the provisions as explained by UpCounsel.
Forfeiture: Under this provision, the investor will have to forfeit his or her allotted capital commitment. In most cases, another general partner will purchase the committed fund.
Conversion: The amount invested by the LP will be converted to non-voting rights. This means that the defaulter cannot vote to support or go against a decision made by the VC firm.
Calling the entire commitment: Here, the venture capital firm decides to call off the capital given to the investor. This may attract penal rate.
Sale of interest: In this case, the investor must sell his or her interest to a third party at a lower price or at a discount.
Withholding against future income distributions: The limited partner will not be paid any future income distribution if he or she didn’t pay the call.
Use loan for the commitment: The VC might request for a loan from a commercial bank, other third party or from a non-defaulting limited partner. This loan will be used to cover the unpaid call.
Double entry for Capital Call
When such calls are made, the double entry is usually to
Dr: Bank account and
Cr: Call a/c.
When all the call amount requested have been fully paid
Dr: Call account and
Cr: Capital a/c
If a LP default in payment for the call
Dr: Forfeiture a/c
Cr: Call a/c (if the provision is that the LP upon default must forfeit the call)
Capital call or drawdown or takedown is used by VC firms to collect part of the liquid fund from limited partners. If the investors default in payment, provisions are made to ensure that the call is fully paid.