In order to close an investment round that will boost a high-growth company, venture capital funds also need to be financed. To achieve this, entities such as BBVA Spark provide these funds with financial products such as capital call lines, credit lines aimed at increasing their liquidity and accelerating the investment process in startups.
Behind the headline of the latest investment round that a startup has closed to boost its growth, is the work of the venture capital funds that have participated in it to make the company evolve and scale up. Just like startups, venture capital funds themselves also need financing to invest in them. To meet this need, they can turn to capital call lines, lines of credit designed to increase their liquidity in order to accelerate their investment processes.
How does an investment fund work?
To understand how capital call lines benefit startups, it is first necessary to explain how a venture capital fund works. In essence, it has two fundamental figures:
- General Partners (GPs). Partners (or managers) who manage the venture capital firm, i.e., are in charge of its administration and of developing the investment strategy in high-growth companies.
- Limited Partners (LPs). Also known as “silent partners,” they provide capital to enable the partnership to make investments in high-growth ventures, but are not responsible for making strategic decisions. To this end, the LPs sign a contract whereby they agree to provide a specified sum of money to the fund for a specified period of time, in exchange for shares in the invested companies.
When a venture capital fund plans to make an investment in a startup, it usually does not have enough money to close the deal. Therefore, it carries out a capital call to LPs. For example, an investment fund launches a €10 million fund to invest in companies in the deeptech sector. It closes a deal to make an investment of 500,000 euros in a startup in a specific sector, but it only has 100,000 euros on its balance sheet, so it needs to raise the other 400,000 euros. To raise capital, it makes a capital call, i.e. a 5% “call” or request to its LPs, which will enable it to raise €500,000 (5% of the total fund, $10 million).
The LPs associated with the fund have committed capital in the range of 50,000 to 200,000 euros. If an LP has committed €50,000, it will have to contribute €2,500 to this investment round. If another LP has committed €200,000, it will have to contribute €10,000.
What are capital call lines for?
When a venture capital fund is close to closing an investment round and makes a capital call, GPs must deal with two issues that can jeopardise the deal. On the one hand, they need to make sure that the LPs do not end up giving money (something that can lead to legal problems) and, on the other hand, that even if they do, the collection of the amount requested from the LPs is delayed for several days.
To anticipate the investment of LPs, venture capital funds can turn to capital call lines, lines of credit offered by initiatives like BBVA Spark. Thanks to them, they can have the necessary liquidity to invest in the startup immediately and accelerate the process until the money from the limited partners arrives.
Benefits of capital call lines
In addition to accelerating startup investment processes, capital call lines have other benefits, as the Institutional Limited Partners Association points out, so that high-growth companies can be provided with new capital.
- They improve the service offered to the LPs. By increasing the visibility of capital requests, capital call lines are a benefit to Limited Partners.
- They avoid exceeding capital requests to LPs. For GPs, capital call lines are a good way to avoid too frequent requests to LPs for liquidity. Frequently turning to LPs could lead to tensions between partners and jeopardise their participation in future operations. As a result, GPs tend to include the specific number of capital calls per year they intend to make in their management documents. By doing so, investors take into account that they will only need to have liquidity to respond to these requests.
- They facilitate investment if there are payment delays by the LPs. Capital call lines are a useful tool in cases where there are operational problems or delays due to disagreements with the GPs. Therefore, capital call lines make it possible to continue with the operation and close investment agreements.
- They provide flexibility to close transactions. In investment rounds that close quickly or in situations where the venture capital fund has to react to unforeseen events in a portfolio company, capital call lines provide a high degree of flexibility to continue investing in startups.
- They improve the profitability of investments. The proper use of this tool allows for a more efficient use of the capital disbursed by the LPs and improves the internal rate of return (IRR), an indicator of project or investment profitability. The higher the IRR, the higher the profitability.
In the financing equation, high-growth companies are not the only ones that need to clear the unknowns to obtain financing. Tools such as capital call lines help venture capital funds achieve the same goal, which is to encourage innovative and technological companies willing to open up new futures and generate opportunities.
