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Last month, I missed a $25,000 capital call without even realizing it. The Managing Partner of the fund, a friend I’ve known since business school, texted me while he was on vacation.
He wrote, “Hi Sam—hope you’re having a good summer. I’m texting from Holland—sorry for the quick note, but just a reminder that the capital call is overdue.”
Yikes! What capital call was he talking about? I’m usually very diligent about meeting all my capital calls, scheduling the wires as soon as I receive them. Apparently, the email notification either never got sent or ended up in my junk folder. However, I couldn’t find the email in the junk folder either.
Unfortunately, I didn’t have $25,000 in my checking account at the time because I had transferred everything to my brokerage account to buy stocks. I’ve been on a mission to get my public equity exposure back to around 25% of my net worth since I bought a house in October 2023.
Not only was I two weeks late for the capital call, but I also had to tell the Managing Partner that I needed another week to send the funds. I had to wait until the beginning of the month when all my rental income comes in.
The Consequences Of A Limited Partner Not Meeting A Capital Call
There were no consequences for me as a limited partner for missing my capital call. Why? Because I eventually paid it. I’ve never failed to meet a capital call, even if it’s late.
Additionally, I’ve been an original limited partner since my friend started his company around 2013. Back then, he had an idea but no track record of his own, yet I still supported him with a six-figure check. Now, he’s onto his fifth fund, attracting institutional investors who are writing checks in the eight figures.
However, if I hadn’t eventually met my capital call, there would have been consequences.
Here’s how the capital call process typically unfolds:
- Capital Call Issuance: The venture capital (VC) fund issues a capital call to its limited partners (LPs) via e-mail usually, requesting the necessary funds. LPs usually have between two to three weeks to wire the money or send a check.
- Initial Follow-Up: If the money doesn’t arrive on the due date, the VC fund will typically reach out to the LPs via e-mail. They’ll give a warning, remind them of any grace period, and check to see if there were any issues, like the capital call notice getting lost or ending up in a spam folder.
- Second Follow-Up: As a courtesy, the VC fund will reach out a second time, usually one or two weeks after the initial follow-up, if the money has not arrived. If there is a proper explanation, such as traveling on a month-long safari in Africa with bad wifi, the VC fund may provide a further grace period.
- Penalties Begin: If the LP still fails to provide the funds, the VC might start charging interest on the missing capital call amount or impose a small financial penalty. The goal is to incentivize the LP to fulfill their obligation because the VC fund relies on that money to operate and maintain its reputation.
- The “Nuclear” Option: If the LP refuses to pay, then the VC fund has no choice but to take aggressive action. In many limited partnership agreements, there’s a clause stating that if an LP fails to meet their capital commitments, they may forfeit all their previous capital contributions. Missing just one capital call could result in the LP walking away from a significant amount of money. This is the most severe consequence and serves as a strong deterrent against non-compliance.
Sometimes The Investment Is Already Made When There Is A Capital Call
By the time a limited partner receives a capital call, the VC firm may have already made the investment in a private company. How can this happen if not all the capital from the calls has been received?
The VC firm can invest ahead of time by taking out a line of credit from its partner bank, which usually handles the capital calls. The bank charges daily interest on the borrowed amount, and the VC firm repays the revolving line of credit as the capital calls are fulfilled.
This approach generally works well since capital is typically received within two weeks of being called. In additional, only a minority of limited partners will be late paying their capital calls. Hence, the interest expense won’t be so great.
In the world of top private companies, VC firms must compete fiercely to gain the opportunity to invest. In venture capital, the firm that offers the most favorable terms wins. A key part of offering the best terms is the ability to wire funds immediately after the term sheet is signed.
Private companies often have a limited amount of investment they want to accept, which means there are only so many VC firms and key individuals who can get in. The company aims to choose investors who provide the most value while also allowing them the freedom to operate independently.
Missing Capital Calls Can Damage Your Reputation
If a limited partner consistently misses or is late on capital calls, their reputation will suffer. For venture capital funds in high demand, this could mean the LP isn’t invited to participate in future opportunities.
Similarly, if a venture capital firm fails to deliver funds after signing the terms, it can face serious reputational damage. Word of any irresponsibility spreads quickly, and such instability can threaten the entire fund.
No one wants to work with someone who doesn’t keep their word. Once a reputation is tarnished, it’s difficult—if not impossible—to restore. In an industry as competitive and capital-rich as venture capital, meeting capital calls on time is essential.
To prevent these issues, VC firms and their LPs create a limited partnership agreement (LPA). This agreement outlines the roles, responsibilities, and benefits for both parties. These documents are meticulously crafted and often include special provisions for LPs, such as reduced fees or positions on advisory boards—benefits that are protected by the agreement.
One of the most crucial components of an LPA is the penalties for missing a capital call. These penalties are intentionally severe to emphasize the importance of meeting financial commitments.
Most Common Reasons Why LPs Miss Capital Calls
Here are the main reasons why LPs miss capital calls.
Administrative Errors: Simple mistakes like miscommunication, clerical errors, or the capital call notice being lost in transit or flagged as spam can lead to a missed deadline. This is the most common reason why LPs miss capital calls.
Liquidity Issues: An LP might face unexpected liquidity constraints, making it difficult to fulfill the capital call on time. This could be due to market downturns, cash flow problems, or other financial setbacks.
Investment Strategy Changes: Sometimes, LPs might reconsider their commitment to a particular fund due to changes in their overall investment strategy, portfolio adjustments, or shifts in market conditions. They may intentionally delay or avoid funding as a result. This is rare given a fund will usually follow its charter agreement.
Disputes or Concerns: LPs might have concerns about the management of the fund, its performance, or the direction of its investments. This can lead to hesitation in fulfilling a capital call as they assess the situation or seek to resolve disputes. During the global financial crisis, some limited partners intentionally withheld funds because they didn’t want to “throw good money after bad.”
Operational Delays: Institutional investors, such as endowments or pension funds, often have complex processes and multiple layers of approval that can delay the disbursement of funds.
Economic or Political Uncertainty: Broader economic or geopolitical events can cause LPs to hold back on fulfilling capital calls as they reassess risk and exposure in volatile conditions.
Banking or Transaction Delays: Delays in banking transactions, particularly in international settings, can also cause capital calls to be missed, even when funds are available and ready to be deployed. It is more cumbersome to send money internationally if you so happen to be traveling abroad when a capital call is due.
Limited Partner Defaults Are Rare
Due to the harsh consequences, LP defaults are quite uncommon. When a new VC fund is launched, it typically draws down a substantial portion of capital right at the start—often around 10% of the total fund. One reason for this initial drawdown is the “nuclear bomb” clause, which serves as a strong deterrent against future missed capital calls.
VC firms are highly focused on maintaining a strong internal rate of return (IRR). The time that money remains invested plays a crucial role in that calculation. Despite their usual caution about drawing funds too early, they make an exception here to ensure that LPs stay committed.
For instance, if you’re a limited partner pledging $250,000 to a VC fund and you’ve already contributed 40% ($100,000) after three years. Missing a capital call could mean forfeiting your entire investment if the “nuclear bomb” clause is invoked. This makes the prospect of missing a capital call extremely unattractive.
While it’s within the VC firm’s rights to enforce this penalty, it’s more common for LPs and VC firms to negotiate an extended grace period to avoid triggering such drastic measures. VC firms know that liquidity crunches sometimes happen. Everybody wins if an agreement gets worked out.
No Capital Calls for Open-ended Venture Funds
Investing in closed-end venture capital and venture debt funds has its advantages. Notably the structured 3-5-year investment horizon during which 100% of your committed capital is called.
Once you’ve made an initial commitment, you’re locked in. But this also means you don’t have to constantly think about where to invest—that’s the GP’s responsibility. Your primary role is to meet the capital calls and monitor the GPs’ performance, who are incentivized by a carry (a percentage of profits) to deliver results.
In contrast, open-ended venture capital funds, such as those offered by Fundrise, don’t require capital calls. You can invest as much or as little as you wish ($10 minimum), whenever you want. This flexibility is appealing for those with uncertain cash flow or limited funds.
Additionally, open-ended funds allow you to redeem capital if you dislike the new investments or need liquidity, a feature not available in closed-end funds under normal circumstances.
My Future Venture Capital Investment Plans
Personally, I plan to reduce my investments in closed-end venture capital funds. I’m currently managing nine, which becomes cumbersome at tax time due to all the K-1s and late K-1s. My latest inadvertent missed capital call likely won’t be my last.
Additionally, I have too much capital tied up in these closed-end funds that often take 7-10 years to return capital. Now that I’m in my late 40s, I unfortunately need to be more careful with my liquidity, as I might never see it again. Therefore, I will probably decline upcoming fund offerings.
Instead, I will focus on dollar-cost averaging into Fundrise’s venture product, where I currently have $143,000 invested. This will be my primary method of gaining exposure to private growth companies, particularly those in artificial intelligence.
My recent dinner with Ben Miller, the CEO, has bolstered my confidence that Fundrise can compete in gaining access to some of the most attractive private companies, both now and in the future. Here’s an interview I had with him earlier in the year.
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