Updated: Feb 12, 2020
What are capital calls?
A capital call (also known as a drawdown or a capital commitment) is a legal right of an investment firm or an insurance firm to demand a portion of the money promised to it by an investor. When an investor buys into a private equity fund, the firm makes an agreement with the investor that the funds will be available when the fund needs them. The investor holds onto their funds, keeping them in a favorable and stable investment account, such as a mutual fund, so that the investment can continue to gain value until the private equity fund needs it. A good example of this is a real estate investment fund: the fund may make agreements with investors to use their money at a later date, such as when the real estate is at a good buying price, at which point they’ll make a capital call to request the money from the investors.
More and more, capital calls are being used for a number of reasons. Capital calls provide flexibility that is appealing to investors, as their funds are not tied up in an investment prematurely and can still provide interest and appreciation to the investor.
Capital calls are appealing to private equity firms because they give short-term access to funds, allowing them to react more easily to changes and shifts in the market as well as investment projects that go over budget.
What are the potential pitfalls of capital calls?
Capital calls have their risks. Because a private equity firm doesn’t have the cash in their bank accounts, investors may fall through and you may be unable to obtain all the funds that are necessary to finalize the investment. Firms use a variety of tactics to stop investors from falling through on their commitments, such as sanctions and withholding future income distributions.
Another potential problem with a capital call is that if issued too soon, a firm may end up with too many funds. You should only use capital calls when a deal has been reached, not on speculative deals or operational costs.
Relying too much on capital calls can make your fund appear unstable to investors, as firms that use capital calls typically have lower liquid assets available.
How can a virtual data room help with documentation when performing those capital calls?
When raising capital, information transparency is one of the most important things an investor will want to see. People who are going to invest in your company want to be informed about all aspects of your operation. Lenders want to make sure you can pay them back with interest. Investors want to be sure their investment will appreciate and pay dividends.
A virtual data room provides you with many features for easy documentation and document management. For instance, when you upload documents to your data room, they are automatically numbered and indexed, allowing for easy navigation.
Files can be uploaded in any format, and a full-text search is available for a quick search to find exactly what you or your investors need. Documents are also fully secure through dynamic watermarks, remote shredding, virus scanning, and document permissions.
No plugins are necessary for the use of a virtual data room, and you don’t need to install any new software. And the VDR is available on Windows, Apple iOS and Android.