Happy Friday, Funds Family!

Today we’ll discuss the process of calling capital ☎️ from investors.

📞 Your first capital call

An LP’s capital commitment is the full amount of money the LP has agreed to invest in a fund or syndication.

Once you hold your fund’s initial closing, you can issue your first capital call notice to LPs. In this notice, you ask investors to send you money by a certain date. 📆 

In many fund documents, LPs have 10 business days to send the money after the GP calls capital. In some fast-moving syndications, the time limit might be tighter for the initial capital call.

An investment fund’s very first capital call often includes money for the following:

• Reimbursing the fund principals for the costs incurred to form and raise the fund

• Paying the first quarter’s management fee 

• Amounts to make the fund’s first investment(s)

Once you issue the first capital call, you’re off to the races! 🐎 

🤔 Why not call 100% of the capital immediately?

There are two (related) reasons why you shouldn’t call more capital than you need.

1. IRR Metrics. Internal rate of return (IRR) is a time-based metric. The less time you hold an investor’s dollars, the better the IRR. Therefore, you don’t want to call capital unless you need it for live deals or imminent expenses.

2. Preferred Return. The preferred return - like IRR - is calculated based on when the LP’s capital enters the fund. The longer you wait to call capital, the less preferred return accrues.

In practice, the cadence of calling capital varies from fund to fund.

🫱 On one hand, GPs want IRR to be as high as possible (and the pref to be as low as possible).

🫲 On the other hand, you don’t want to annoy LPs by calling capital every 15 days just so you can optimize return metrics.

📄 What goes in a capital call notice?

Two things absolutely must go in a capital call notice:

1. How much money does the LP need to send?

2. When is the due date?

Some funds might also specify what the capital will be used for.

In some cases, LPs might request in the LPA (or a side letter) that capital call notices contain a detailed list of uses (e.g., management fees, investments, and other fund expenses).

🧮 Capital calls are typically pro rata

In most investment funds, capital calls are pro rata, which means every investor puts in the same percentage of their capital commitment.

There are special circumstances (such as excused investments) where this isn’t the case, but nine times out of ten, capital is called pro rata based on commitments.

💼 Who is in charge of calling capital?

If the fund has a third-party fund administrator, the administrator will handle calculating the capital calls, issuing capital call notices, monitoring incoming wires, and updating the fund’s books and records.

If the fund doesn’t have a third-party fund administrator, someone on the GP’s team will be responsible for calling capital.

If you have the financial capacity to hire an administrator, it’s often a good idea.

💵 Why do people on the internet sometimes complain about capital calls?

After reading this article, you should have a solid understanding of capital calls.

So why do people on the internet demonize capital calls and suggest that “calling capital” is the sign of a bad GP?

💡 Answer: They’re talking about calls for “additional capital” in syndications

Our internet friends aren’t complaining about normal fund capital calls like we’ve discussed today.

They’re talking about calls for additional capital above and beyond an investor’s initial commitment.

For example, someone might have a $100k commitment to a real estate syndication, which has been fully funded.

Due to economic conditions or poor execution, the syndication might be in hot water and need additional capital. 🥵 

Many syndication documents have a mechanism where the GP can issue an optional capital call notice to raise extra money. While these capital calls are technically optional, non-funding LPs are typically diluted if they don’t fund the “optional” additional contribution. In some syndication documents, there’s punitive dilution where non-funding LPs really get whacked if they decline to wire additional funds.

So, that's why some people don’t like capital calls.

But now you understand that these are not the same capital calls as those in a multi-asset fund that draws down capital over time, which are completely normal.

Thanks for reading, everyone.

Have a great weekend! 🙌 

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This newsletter may be considered attorney advertising.