Capital call in a VC fund and how that impacts payouts
A refresher: Generally, when we raise capital for our fund, we do not take the full amount committed to the fund from an LP upfront. Instead, the capital is called upon in phases or installments (known as drawdown).
Factors that influence drawdown in phases
GP standpoint
- Helps with managing IRR — IRR clock starts ticking when we drawdown capital and phased drawdown helps to balance it. (Cash drag)
- This also helps an LP to commit to a fund if the overall commitment is drawn over a period with a small initial drawdown.
- Capital calls are legally enforceable. An LP who defaults on a capital call risks penalties and legal consequences.
LP standpoint
- Gives LPs flexibility to manage their cash — they could invest it elsewhere till the drawdown date
- For new LPs to this asset class, it eases them into the process
- If your fund pays out the treasury earnings to LPs (interest earned from undeployed drawdowns), then it helps LPs to cover part of their future drawdowns.
Simple illustration showing the impact of drawdown on IRR in both scenarios (all things being equal):
Excel model for the above table can be accessed here — (it also has a surprise another model) — http://bit.ly/407Kd4B
Few things to consider:
- Agree on a capital call schedule — quarterly / every 6 months — this is especially true for
a. smaller funds which has to be more nimble
b. If you have larger number of LPs to manage as adhoc capital calls could make the process messy for you and for them
c. It will help manage operations better
2. Give LPs enough notice to arrange for funds. Your LP agreement might state x number of days but it is good practice to give a heads-up to LPs before the actual notice is sent.
3. You may not be able to do drawdown beyond a certain cap in a year, for eg, 50% of overall capital commitment. So plan your investments accordingly.
4. Don’t delay your capital call if you have agreed with your LPs a drawdown schedule.
5. There is risk of LP default so plan your fund deployment plan with the scenario a certain % could default.
In summary, capital call planning involves balancing the timing and amount of capital calls with the fund’s investment performance.
Additional reading on this:
