Recently, the topic of private equity has begun to light up more and more. Perhaps this is due to the trend of profitable capital investment, but even despite a lot of information on this activity, people still may not know or understand a lot of nuances and terms. So, one of the frequent questions that arise among those interested in the financial industry is: what is a capital call? In this article, we’ll look at this concept from all angles, why it’s needed, and what the implications are.
What is a capital call?
A capital call is a process of raising money from limited partners, and it can be done as many times as needed. It works like this: an investor buys a private equity fund, and the firm makes a deal with it that it can use that capital whenever it needs it. Investors, of course, have an advantage from this deal because now, their funds will be held in a lucrative investment account, and the investment will gradually increase until the organization is needed.
Typically, private investment organizations request funds from this account when the deal is about to close. Investors have a limited amount of time to provide the company with this money (7 to 10 days). Sometime after the investor has given the desired amount, it comes back due to the capital call.
Private equity capital call – when is it best used?
The most frequent practice of capital calls in all the times of business has been with real estate companies. Organizations spend some time looking for profitable real estate investments before they make a purchase, so they don’t need instant access to investor funds. But now, nevertheless, the number of private equity funds that use the capital call method has increased markedly. That’s because it offers a number of advantages, one of which is increased flexibility. This opportunity is great for the investors who are looking to profit monetarily from it. Also, because the investment funds are spread out over a long period of time, investors can increase the profitability of their capital investments while they wait for a request for that money to be issued.
In addition, capital calls can help a company better cope with emergencies and changes in the marketplace, as well as unexpected costs.
Risks and perils of capital calls
Every business operation has its risks, and in the case of a capital call, the consequences may not be pleasant either. Since you don’t actually own the funds in question, until they are transferred to your bank account, you won’t be able to receive all of the funds promised by investors, which could result in a default. To prevent this from happening, investment companies use some precautionary methods, such as sanctions against the investor and withholding of subsequent income.
Also, you don’t want to call in the capital too early, before the deal is done, because that way you will get too much money. In any other situation, this would seem to be a positive thing, but you should only spend the money to fund investments that have already been done. In addition, you may develop a kind of dependency on capital calls, and if you do this too often, your firm will become an unreliable platform for many private investors, as your liquid assets will diminish markedly.