Cash Flow Management Component 3 of 4
What is a capital call line of credit?
A capital call line of credit is a facility provided by a financial institution (i.e., Silicon Valley Bank) in exchange for interest. General partners (GPs) draw funds from these facilities on a regular (often quarterly) cadence instead of calling capital directly from limited partners (LPs). These facilities provide a streamlined, time-efficient way to fund investments and manage cash flows without the risk of LP default. They can also offer attractive returns optimizations.
"The ability to delay calling capital enhances the manager's flexibility to execute deals and shortens the J-curve, enhancing the fund's IRR, particularly early in a fund's life, and therefore its competitiveness on a quartile basis. From an LP perspective, the use of these lines helps smooth cash flows and eases the administrative burden of responding to capital calls," according to Institutional Limited Partners Association (ILPA).
A capital call line also mitigates the need to reserve unused cash balances to fund investments within a short period, by bridging the gap between funding the investment and the next capital call.
There are a few considerations to be aware of before putting a capital call line of credit in place:
- Determine whether your specific strategy merits a capital call facility.
For instance, very concentrated strategies may not require one. On the other hand, strategies that include high reserve ratios may benefit substantially from the discipline they enforce. - Work with your fund counsel to determine if your LPA agreement allows credit facilities, and if so, what percentage you can leverage. Often, 15% of the fund size is the maximum allowable amount.
- Consider the costs and process against your operating company plans. Capital call facilities can be relatively low cost, but they do require additional legal fees to set them up and administrative resources to maintain them
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