Last September Hustle Fund raised $46 million for Fund III. So it must feel pretty baller to have all that money in the bank to invest in whatever we want, right?

Except we didn’t have $46 million in our checking account, even though we already raised that money.

How the heck does that work?

Now would be a good time to review our previous article, What to expect when you’re expecting VC funding. 

In this episode of UnCapped Notes, we’re diving deep into the most common reason for delays in receiving money. Let me tell you all about a VC process called capital calls. 

What really happens after a VC commits

Let’s say we have a talented founder named Janel. We tell her that she’s amazing and we’d like to invest $250,000 into her company.

Janel is thrilled. She signs the documents, gives us the wire information, and waits. Weeks go by and she’s still waiting. She’s wondering, “What’s taking so long?”

As VCs, we may not have the total amount of cash on hand that Janel needs. We first need to call down capital from our Limited Partners (our investors) to give it to Janel.

This capital call process includes:

1. writing an investment memo
2. documenting why we’re investing
3. informing our LPs that we have a deal that’s ready to fund

AKA - “LPs, give us some money that we raised from you so we can fund this awesome startup.”

Money is normally called down by percentages. So our fund admin (who manages cash flow) may tell our LPs that we want to call down 1% ($460,000) from our Fund III. Or we want to call down 10% ($4,600,000).

So how long will it take for Janel to receive the money?

A typical capital call takes two weeks. And there's a two-week grace period window for that LP to send the money to the VC fund. So there could be some delays.

At Hustle Fund, we actually have a different kind of capital call structure. We call a little bit more money than we normally need at any given time so we can wire money faster. That process is slowly starting to become more of the norm, but it's still pretty infrequent.

Delays are somewhat common but it is rare for an LP to completely miss or ignore a capital call. To spare you the details, there are severe consequences to the LP if this happens. Plus it massively damages their reputation.

Why does the process work like this?

Imagine we received all $46 million that we raised upfront and we issued a $250k check to Janel.

That means $45,750,000 is left sitting in our checking account. That’s money not being put to work. Maybe not even earning any interest.

That money could be back in our LPs’ hands to generate more cash.  They can invest in index funds or real estate or something else as they wait for us to fund deals.

This concept is referred to as the internal rate of return (IRR).

So the norm in VC is to ask for little portions of that money along the way. Typically over the course of years. When we have a deal that's ready to fund, we'll ask our investors to give us that money, which in turn we give to the founders.

Founders who understand this process can ask good questions like, “What percentage of your fund has been called?”

This question is insightful because it’s generally considered very bad practice to invest an initial check if your fund is over 90% called.

It’s also a bad user experience for the founders too. Let’s say we sneak the first check into Janel’s startup even though our fund has been 95% called. Then Janel says, “Things are going great and I’d love to work with you to lead our Series A.”

But we have no more cash left and we are forced to say no to Janel. We miss out on an opportunity. Plus she is slightly blindsided since she thought she had the option to work with us more.

Now you know how everything works...

You now know why capital calls are often the source of delays. Know what to expect after you raise money. Elizabeth Yin (one of our GPs) published a tweet thread going into more detail if you’re curious.

This also would be a good time to read our article, Make sure your new investors are legit, for more good questions to ask.

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Until next time,

Tam “call down the money” Pham