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📰 Today's topic: how capital calls work

When I joined Hustle Fund 6 years ago, the company was in the middle of raising Fund II.

When we closed the round, I assumed that meant our bank account was loaded. Meaning… we had tens of millions of dollars in the bank.

Boy, was I wrong.

How This Beautiful System Actually Works

Here's the deal: LPs don't hand over their full commitment upfront. Instead, it’s like a really fancy, legally-binding IOU system.

LPs commit to a certain amount, and then fund managers call their capital when they actually need it.

Here's how it plays out:

• Day 1: LP commits $100k, VC asks for 30% initial drawdown → LP wires $30k

• Month 6: VC spots a great deal, issues a 20% capital call → Another $20k flows in

• Month 12: More investment opportunities, another 25% call → $25k more hits the account

• Month 18: Final call for the remaining $25k → Boom, fully deployed

Why Everyone Wins

This system exists for a reason. There’s a method to the madness.

For fund managers:

• It’s easier to fundraise: LPs are way more likely to say yes when they don't have to cut a massive check immediately

• Better fund performance: When cash sits in your fund but doesn’t return any money to LPs, it makes your IRR look worse than it is. This concept is called “cash drag”, and you don’t want it. So deploying capital as soon as it hits your bank account is ideal.

For LPs:

• Better wealth management: LPs can keep some of their money available for other investments, potentially even making returns that enable them to re-invest in your fund (or co-invest alongside you)

• LPs don’t like being illiquid: Less money tied up upfront means more control over their portfolio

• Distribution magic: Early wins can actually cover future capital calls

The Boring-But-Important Legal Stuff

Capital calls might be fancy IOUs, but they’re also legally binding obligations spelled out in your LP agreement.

Your LPs can't ignore them without consequences. Here are some typical terms in an LPA:

• Payment window: Typical LPAs give LPs between 7 and 30 days to transfer funds.

• Deployment guardrails: This limits how much you can call within specific periods. LPs like this because it prevents GPs from deploying their fund too quickly.

• Worst case scenario: If an LP doesn't comply with a capital call, there are consequences. These range from reduced distributions to legal action and losing all ROI opportunities.

When Things Get Awkward

Even the best systems could go sideways. Here are a few things to watch out for:

• Bad timing: Your LP committed in 2021, but now it's 2024 and they're feeling... less enthusiastic.

• Urgency: Waiting 14 days for an LP to transfer capital for a deal that’s already over subscribed. Hello, anxiety.

• Administrative complexities: Figuring out how much each LP should transfer, then handling all the communications around each request can be a huge burden. Fund admins for the win!

• When LPs default: When an LP can't (or won't) fulfill their obligation, it’s on the VC to play hardball. If you don’t, you set a risky precedent for your other LPs.

A Capital Call Playbook

Managing capital calls is a must for fund managers. We recommend…

1. Over-communicating: Give as much advance notice as possible. We include the capital call schedule in our monthly LP updates so there are no surprises.

2. Enforcing your LPA: You have an LP Agreement for a reason. Know the terms you negotiated, and don’t be afraid to enforce them.

3. Having a Plan B: You can get a capital call line of credit, which is a great backup plan in case LP dollars don’t come through in time.

If you only remember one thing from this article…

Capital calls are venture capital 101 – everyone does them, but not everyone does them well.

The difference between drama-free capital calls and a big ‘ole headache usually comes down to clear communication, realistic expectations, and actually understanding what you agreed to in the LP Agreement.

This is why we have a fund administrator,

Kera from Hustle Fund

The rise of seed-strapped startups

There’s a new crop of startup founders who are raising a seed round… and then nothing else. No priced round, no series A, nada.

There are huge benefits to investors. And also some pretty big question marks (like, will I make any money off those deals?).

Let’s discuss →