Quickfire Q&A
Ben Palairet and Hugo King-Oakley
Global Partnership Family Offices
Capital calls are when an investor in a private equity or venture capital fund is required to contribute additional capital to the fund. This typically happens when the fund’s managers have identified an investment opportunity and need more capital to fund it. Capital calls can also occur if a portfolio company in which the fund has invested requires additional capital to fund its operations or growth. Capital calls can be a regular part of investing in a private equity or venture capital fund, and investors should be prepared to meet them when they arise.
**Why Do Capital Calls Exist?**
The purpose of a drawdown process is really driven by the metrics used by private equity. In a liquid fund, you can invest capital straight away and it can generate a return. In the private environment, if you committed capital right away, you would have dormant cash sitting unused for a period of time.
The two primary return metrics in private equity (and private funds generally) are IRR-based and money multiple-based. These are all about the cash put into the system and the cash that comes out. Why is this important? The real financial driver for all General Partners (GPs) is their carry. This is driven by a waterfall, and part of that is driven by IRR. It is therefore core to the administration mechanics of private funds. The issue with drawdowns is that they can happen at any time—and they do.
**How Do Capital Calls Typically Happen?**
In private equity and other private market investments, capital calls typically occur when a GP needs additional funds from their Limited Partners (LPs) to make investments. The GP will issue a notice to the LPs, requesting that they contribute a specified amount of capital to the investment vehicle within a certain time frame. LPs are contractually obligated to meet their capital call commitments unless they have negotiated specific terms in advance. Once the LPs have contributed the funds, the GP can use them to make investments or take other actions on behalf of the investment vehicle.
Funds mostly intend to pace capital calls, which can be any amount up to total commitments, during the investment period. However, this often does not play out at an even pace, as opportunities arise during the investment period in a non-uniform manner.
There is a structure to how drawdowns happen, although they can appear quite ad hoc. If a fund manager has a plan to invest in 20 deals over a five-year investment period, that equates to roughly one per quarter, and deal sizes will typically be of a similar scale for portfolio management purposes.
It is typical, especially in venture and growth fund strategies, to “reserve” for follow-on investments. This means the fund intends to call approximately 70 per cent of committed capital during the investment period and call the remaining 30 per cent later for follow-on investments.
It can be more difficult to judge expected capital calls for follow-on investments, as those are truly ad hoc. Sometimes funds do not call all committed capital because they have access to credit lines.
It is worth noting—especially with the increased participation of family offices and investment in smaller or emerging managers—that this introduces additional nuance. The complexity of liquidity planning with smaller funds is higher, particularly with first and second closes. For example, at first close a fund may draw in excess of 50 per cent of commitments, and at second close there can sometimes be an equalisation process where cash is returned, which can be perplexing to LPs.
**Why Do Capital Calls Matter to Family Offices?**
Capital calls can be an important consideration for family offices because they represent a potential additional financial commitment. Family offices typically invest in private equity and venture capital funds as part of a diversified investment portfolio, and capital calls are a regular feature of this type of investing.
It is important for family offices to be aware of the potential for capital calls and to have the financial resources in place to meet them when they arise. Additionally, family offices may wish to carefully consider the terms of a fund’s capital call provisions before investing, to ensure they are comfortable with the potential financial commitments involved.
However, insufficient focus is often given to the “money waiting” period, when commitments have been made but capital has not yet been deployed. This is an important issue from both a governance and investment perspective. Investors should consider how to invest their money during this waiting period and account for the risks and performance characteristics of assets during this time. It is also important to manage cash flows across different private asset investments and ensure commitments to GPs are met on a timely basis.
Best practice is to adopt a dynamic investment framework—a strategy for managing investments that adjusts to short- to medium-term projections of cash flow requirements. This means the allocation of assets within the investment portfolio is regularly adjusted based on expected future needs for cash.
This approach allows for a more flexible and responsive investment strategy, enabling changes to be made in response to evolving market conditions or cash flow needs. While commonly used in private asset investing, a dynamic investment framework can also be applied across a broader family office investment strategy.
