Let's talk about capital calls -- it's a mundane topic that no one ever discusses but the strategy behind capital calls is super interesting (to me) and is applicable to both founders and fund managers:
Some thoughts below:
Some thoughts below:
1) When a startup raises money, you sign docs and wire all the money at once when the round closes or after you sign a note or something.
But, when a VC fund raises money, in most cases, it doesn't ask for the money from its investors right away.
But, when a VC fund raises money, in most cases, it doesn't ask for the money from its investors right away.
2) In other words, for our $11.5m Hustle Fund 1, we never had $11.5m sitting around in our bank account at any point in time.
3) And it obviously makes no sense to have $11.5m sitting around in a checking account doing nothing. So instead, most funds do capital calls -- they ask their investors for a portion of their investment bit by bit across a period of time.
4) Why is this interesting? There is a lot of strategy to the capital calls. Your % of return is calculated based on when you do capital calls. E.g. if you call 50% of your fund & keep it earning 0% interest in your checking acct, your IRR is going to be impacted in a bad way.
5) You want to be doing a capital call as close to the time of an investment as possible. As such, a lot of funds do capital calls right when they are about to sign a deal.
6)This works well if you don't do that many deals per year. But if you invest in 50 companies per year (like we do), your investors will start to get annoyed if they have to wire money every week.
7) Also if you do a capital call right when you sign a deal, you will still need to give your investors a grace period to send you as the fund money before you can invest in the startup, so there is a bit of delay somewhere. For hot deals, this can be challenging.
8) This introduces the opportunity of loans for VCs! With a loan, you can bridge some of these problems. E.g. not make your LPs super annoyed with you by doing capital calls all the time and also be able to wire money immediately to your founders.
9) This seems like a fantastic opportunity because there's virtually no risk to a lender (the money has been legally committed to the fund - it's just not in the bank yet). Just an interesting phenomenon in the industry because of the way things are structured.
10) When we were first starting out, we could not get a loan, so we as emerging fund managers were playing banker and loaning our fund money between capital calls! This is lesser talked about but something new fund mgrs must often do.
11) If a fund manager has fully raised a fund, then it's a lot easier to get on a good cadence of doing capital calls. E.g. once every 6 months or whatnot. You have a good sense of your pacing and how much money you have in your fund.
12) But if you are raising and deploying in parallel, then the strategy is super interesting, because you ultimately don't know how big your fund will be. Will it be $10m? Or $20m? Who knows? You need to do a capital call, but you don't want to call too much.
13) And as new LPs join your fund and invest in your fund, they immediately "catch up" -- send you the % of money that everyone else has sent -- so you get an influx of money from new LPs.
14) For example: say you've raised $5m and you do a 20% capital call. This means that your investors will send $1m to your fund checking acct. If you raise another $5m in the next quarter, those investors will need to send you $1m to "catch up".
15) You know you may need $1m next qtr to deploy in startups, but sometimes it's unclear whether you will be able to raise more money and just get $1m from catch ups. Or whether you should do another capital call of addl 20% with existing investors.
16) If you end up inadvertently doing both, then you'll have $3m sitting around instead of just $1. ($1m from existing investors and $2m from new investors catching up to the total 40% capital call)
17) In addition, if you then raise more money from more LPs after that, then those people will also have to catch up to the 40% capital call, so you could get an influx of too much cash in your acct just sitting around.
18) If you're lucky enough to have a loan, you have an extra lever to pull. Instead of doing another capital call, you can take out a loan if the investor commits fall through. You end up paying interest on that loan but it may be better than killing your IRR with too much cash.
19) I don't really have any interesting takeaways, but the structure is just fascinating to me and the opportunities (such as the loans) it creates through this somewhat strange money movement. Curious for other people's thoughts.
