Investing in private equity: not all at once
You commit an amount, but pay it in stages, as and when the fund needs the money. Each of these requests for payment is called a capital call.
In private equity, the amount invested is usually not transferred in one go. An investor agrees in advance how much capital to commit to a fund, and the fund then calls that amount in instalments during the fund term. Each of these requests for capital is known as a capital call.
This system is characteristic of private equity and reflects the way private equity funds invest. A fund builds its portfolio gradually. New investments are made over several years, and existing portfolio companies may also need additional capital later on.
But how exactly does it work? And what does it mean for you as an investor?
From commitment to investment
When you invest in a private equity fund, you agree in advance on the maximum amount of capital you will make available to the fund. This is called your commitment.
- 1CommitmentYou commit an amount to the fund.
- 2Capital callThe fund calls part of your commitment.
- 3PaymentYou pay your share before the deadline.
- 4InvestmentThe fund invests the capital raised.
Suppose you commit €1 million to a fund. You do not usually have to transfer that €1 million at the outset. Instead, the fund calls parts of your commitment during the fund term, when the capital is actually needed. That might happen, for example, when the fund acquires a company, makes a follow-on investment in an existing portfolio company or has to pay certain fund expenses.
Until the capital is called, it stays with you, the investor.
What exactly is a capital call?
A capital call is the formal request from a fund to its investors to pay in part of the capital they committed earlier.
If a fund wants to finance a new investment, for example, it determines how much capital it needs to call from its investors. Each investor then receives a call notice for their share. Among other things, the notice states how much must be paid in and the deadline for payment. Once they have received it, investors transfer their share, after which the fund can put the pooled capital to work.
A capital call is therefore the link between the capital an investor has committed and the capital the fund actually invests.
Why is your capital called in instalments?
A private equity fund usually invests its capital over several years. If a fund called the full commitments of all its investors at the outset, a substantial part of that money could sit unused in the fund for a long time before a suitable use for it came along. Capital calls are therefore matched as closely as possible to the fund's actual capital needs.
Most of the commitment is usually called during the investment period. This is the period in which the fund is actively adding new companies to its portfolio. Capital calls can still be made after that, however, for example for follow-on investments in existing portfolio companies, management fees or other fund expenses. The exact timing and size of capital calls therefore differ from fund to fund.
A simple example
Suppose you commit €1 million to a private equity fund. The fund does not need to receive the full amount straight away. In the first year, for example, it calls €150,000 for its first investments. A year later there is a capital call of €250,000, followed by another €200,000. After these 3 capital calls, you have paid in a total of €600,000.
| Total commitment | €1,000,000 |
| Called to date | €600,000 |
| Not yet called | €400,000 |
The remaining €400,000 is known as the unfunded commitment. The money is still with you, but the fund can call it during the period in which calls are permitted. That last point is important.
Committed means committed
The fact that capital has not yet been called does not mean the investor is free to tie that amount up elsewhere for a long period. A commitment to a private equity fund is an obligation.
When the fund issues a valid capital call, the investor must pay in their share within the agreed period. That period can be relatively short. Investors therefore need to plan for future capital calls and keep enough cash available.
Failing to meet a capital call can have consequences. What these are depends on the terms of the fund concerned. In the most extreme case, an investor can even lose part of the interest they have already built up.
Why does private equity work this way?
The capital call model means that investors' capital is, as far as possible, called when it is actually needed. For the fund, this means it can draw down capital when investments or other expenses need to be financed. For the investor, it means that the part of the commitment not yet called remains at their own disposal for the time being.
This makes it fundamentally different from, say, buying a listed share, where an investor usually pays the full purchase price straight away. In private equity, by contrast, there is a period between entering into the investment and actually paying in the full amount.
Good cash flow planning is therefore essential: investors need to keep enough cash available for future capital calls, while the uncalled capital can earn a return elsewhere in the meantime.
