For Venture Capital Firms (VCs) to get funds for Private Equity Companies, capital commitments are necessary. This capital might be invested in a particular startup or a group of them depending on the nature of the fund. In this article, you will learn the meaning of committed capital, explanations to it and how the fund is organized.
Definition of Commitment Capital
It can be defined as the total amount of capital agreed upon by the Limited Partners to finance the fund required by the VC.
Also, it is the sum of all capital needed by the General Partners to invest in Private Equity companies which is provided by the Limited Partners.
Finance the fund. The capital commitment is made to finance the fund required by the venture capitalist to invest in a private equity firm. This fund is a lump sum of money. At times the fund may be higher than the committed capital.
Private Equity Firm. This is a startup company. The firm is a limited liability company. Most of these small companies do not have sufficient capital to scale their business model. Plus, banks may not be willing to provide loans as there may not be enough working capital to pay the loan installments and interest.
Therefore, VC firms provide the funds to these small firms for them to scale and grow within a time frame, known as the committed period. The aim of providing the fund is to help the private equity firm break even and make profit. But for the VC, it is to find a suitable exit route to get back the fund invested.
How the Committed Capital is Organized
The committed fund can be organized in two ways. Via a “blind pool” or for a “specific purpose.”
Blind pool. Here the capital is accumulated in a pool. Next, the General Partners will decide which private equity firm a portion of the fund will be invested that will yield the maximum internal rate of return. This method gives the VC control over the fund as it will be used at their will. Insofar the outcome leads to high return on investment.
However, many investors may not like this. Some investors may prefer to invest their money in a particular business model. One Limited partner may prefer financial technology firms while another may prefer biotechnologies.
Specific Purpose. The second way the committed capital can be invested is to a specific startup. Here, the GP has concluded to invest in a private equity company. Next, it sources funds to finance that company. The purpose of the capital committed may depend on the VC or the limited partners.
The GPs of a particular venture capital firm may prefer investing in early stage startups. Another may prefer investing in a particular business model or in a geographical territory like in Africa. Certain VCs may pursue multistage financing.
To wrap it up, committed capital is the total capital the limited partners agreed to make available to the fund of a venture capital firm. The capital may or may not be equal to the total fund of the VC. Further, the fund might be in a blind pool or for a specific purpose. The capital commitment is usually paid by the LPs in piecemeal, that is on several draw downs.
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