Say Hustle Fund wants to raise a new $20M fund. We find 20 investors who each agree to commit $1M in capital. They wire us the money and we get to investing. Simple, right?

Not exactly.

In reality, most investors won’t agree to hand over $1M in one shot. We also don’t really need them to, given it’ll take us anywhere from 12-36 months to deploy all that capital into startups.

These are some of the reasons venture funds utilize capital calls, in which investors hand over portions of their committed capital over time as needed by the fund. In this guide, we’ll break down capital calls for investors, covering what they are, how they work, and what investors should know about them. 

What is a Capital Call?

A capital call is how a fund manager (also known as a “general partner” or “GP”) collects money from their investors (also known as “limited partners” or “LPs”) when the fund is ready to make an investment. Essentially, the GP will issue a capital call notice to all the fund’s LPs, after which the LPs will have some period of time (typiclly 7-14 days) to wire their capital to the fund bank account.

There are typically three terms associated with capital calls that investors should understand:

• Committed capital: The committed capital is the total amount of capital the fund’s LPs agree to commit over the life of the fund. In our Hustle Fund example, each LP’s commitment was $1M. The $20M we raised was the sum total of all our LPs’ capital commitments.
• Initial drawdown: The initial drawdown is the portion of the committed capital that the fund’s LPs agree to hand over at the start of the fund. For example, we may request that our fund’s LPs provide an initial drawdown of 25% of their capital commitment, or $250k. 
• Paid-in capital: Paid-in capital is the amount the LPs have already given to the fund. If you subtract the paid-in capital from the committed capital, you get the uncalled capital, or the amount the LPs still “owe” the fund. A capital call is the process of converting uncalled capital into paid-in capital.

When a GP sends a capital call notice, it’ll typically include the LP’s share of the amount due, how much of the fund’s capital has alread been called, banking details, and a payment due date. 

Most importantly, capital calls are legally enforceable, meaning if the LP doesn’t pay, they can face legal repercussions (more on this later). The terms of the capital call, including penalties for non-payment, are outlined in the limited partnership agreement (LPA) that the LP negotiates with the fund. These terms vary depending on the fund’s needs and the LP’s leverage, but typically include:

• How much time the LP has to fulfill the capital call.
• The maximum amount the fund can request via capital calls within a specified time period. For example, an LP may demand that more than half of their committed capital not be called within a year.
• The fund’s deployment period (i.e., the time during which it will be investing in startups), given this will also be the time period during which the fund will call the bulk of its committed capital.

Why do Venture Funds Issue Capital Calls?

The capital call structure benefits both fund managers and investors in a handful of ways:

For fund managers:

• Easier to raise money: LPs are less likely to invest if they know they have to hand over a large sum of capital at once. Having an initial drawdown lowers the barrier for LPs to invest because it allows them to better control their own cash.  
• Avoid cash drag: Having money sitting in a fund bank account unused impacts the fund’s internal rate of return (IRR) and total value to paid-in (TVPI), two metrics that are used to evaluate fund performance. Given VC is a reputation and relationship-driven business, a capital call allows GPs to better control fund performance in the early years.

For investors:

• Hold on to their capital: Most investors would rather control their money than hand it all over to the fund. The capital call structure enables LPs to allocate capital elsewhere (and potentially generate a return on that capital) until it’s needed by the fund.
• Distributions can cover capital commitments: If a fund generates a return before calling all of its capital, each LP's pro rata share of that return can be used to cover future capital calls.

Captial Call Cons

While the capital call system can be beneficial to both GPs and LPs, there are a handful of potential drawbacks associated with capital calls:

• GP-LP friction: While investors agree to commit a certain amount to a fund, they might not always be thrilled when they’re hit with a capital call notice. Given funds typically deploy capital over a period of 2-3 years, each LP’s financial circumstances (along with the market’s) can change. For example, LPs that committed capital to funds during the 2021 bull market may be more reticent to hand over that capital if hit with a notice today, given the market has taken a turn for the worse. This is why GPs often need to be strategic when issuing capital call notices, or turn to capital call lines if the timing isn’t good for LPs (more on capital call lines later).
• Delayed deals: Waiting over a week for your LPs to fulfull the capital call can unwravel a time-sensitive deal. This is another instance in which a GP may turn to a capital call line. Fund managers should try to give LPs as much notice as possible in regards to the timing of a capital call. 
• Admin fees. Capital calls often have admin costs associated with them, such as wire transfer fees or legal costs associated with defaulting LPs. 
• LP default: An LP may not fulfill their capital call, either because they don’t have the funds available or (more rarely) because they don’t want to. In these instances, the fund manager must be prepared to take action against the LP.

What Happens if You Can’t Fulfill a Capital Call?

Consequences in the event of investor default are defined in the LPA, and may include:

• Loss of right to contribute additional capital to the fund, and capping the participation of the LP at their current paid-in capital.
• Limited share of future fund distributions.
• Assessing a penalty on top of the capital call amount due.
• Required sale of the LP’s stake in the fund to other LPs or interested third-parties under specific terms.
• Paying damages to the fund as a result of the LP’s failure to meet the capital call. 

Capital Call Example

Say you’re an LP in Hustle Fund and you agree to commit $100k to the fund with a 30% initial drawdown. This means you’ll wire the fund $30k after agreeing to invest, with the other $70k to be called during the fund’s deployment period (36 months, as outlined in the LPA). 

Six months later, Hustle Fund identifies a startup it’d like to invest in, and issues a pro rata capital call of 20% from each of the fund’s LPs. Per the terms of the LPA you agreed to, this means you’re legally required to wire Hustle Fund another $20k within the next 14 days. Your uncalled capital is now $50k.

A year later, Hustle Fund issues another capital call for 25% of every LP’s committed capital. This means you’ll wire the fund another $25k, lowering your uncalled capital to $25k. Finally, six months later, Hustle Fund calls all remaining uncalled capital, meaning you wire the fund your remaining $25k, and have now fulfilled your full commitment.

Capital Call FAQs

What is a capital call line?

A capital call line of credit is a short-term loan secured against future capital calls. Fund managers turn to capital call lines when the timing isn’t good to make a capital call, or LPs are taking longer than expected to transfer funds, jeparodizing a deal. 

Are there limits on capital calls?

Generally, a fund manager only calls capital from LPs during the deployment period, as outlined in the LPA. After the deployment period ends, there are greater limits on when and why GPs can call capital. For example, the LPA may allow GPs to call capital after the deployment period if it’s used for a follow-on investment or to pay legal fees or other expenses associated with the day-to-day operations of the fund. 

Will I ever be asked to commit all my capital at once?

It’s rare that a fund will ask an LP to commit 100% of their capital in one shot, as it doesn’t behoove the GP to hold all that capital if they’re not prepared to deploy it. Calling too much capital at once can adversely affect fund performance metrics, and also cause friction with LPs who were hoping for more control over their commitment.

How do I keep my capital readily available?

In order to ensure you’re able to fulfill your capital calls in a timely fashion, it’s recommended that LPs hold their committed capital in an account that can be easily liquidated, such as a brokerage or savings account. LPs should not allocate committed capital into investments with high degrees of volatility, as this could affect their ability to fulfill their capital call. 

Capital calls: part an parcel with startup investing

Investors in venture funds should understand that capital calls are standard operating procedure in the world of VC. However, there are expectations around how and when GPs should call capital, and how LPs should handle such calls. Knowing what to expect will make you a better partner to GPs, and safeguard yours—and your fellow LPs’—interests.

For more guidance on investing in startups, consider joining Hustle Fund’s Angel Squad. Members of Angel Squad receive mentoring from Hustle Fund partners, along with access to startup investment deals alongside Hustle Fund.

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