A capital call or draw down is a legal right that allows venture funds to demand a transfer of promised funds from investors. The term “capital call” is used to refer both to this legal right and to the practice of actively exercising it. Capital calls are used to ensure that a venture fund has the capital that it needs when it requires it and to confirm that investors are committed to a project.
Contractual Obligation
An investor commits to a fund in a contract that includes a clause explaining the capital call. The investor might not transfer the funds immediately, instead waiting until the fund has received commitments from other investors and has selected a project in which to invest. After the venture fund is ready to embark on a project, it will issue a capital call, at which time the investors will need to transfer their promised funds to the company. The existence of the capital call agreement will attract other investors, showing them that the fund is serious and capable of drawing upon a large pool of investment capital.
Protects the Firm
Venture firms count on accessibility to promised funds when they negotiate potential investments and projects. If investors back out of their commitments, it can be a serious problem for the firm, because it might have made plans for those funds. Capital calls protect venture groups from unexpected shortages in capital and ensure that a flow of funds will be available when it is required.
Assures the Investor
Investors are also protected to some extent by a capital call. When an investor commits to get involved in a venture fund, he or she is assured that other investors will be required to inject capital when a draw down occurs. This means that the venture fund is more likely to succeed and to generate a return on the investment. Investors may rely on the coordinated funds of the whole to generate a good return, so the capital call is critical to their security.
Legal Requirements
When people commit to making investments in funds, they usually will be given information about capital calls and how they work. In some regions, venture funds are required by law to spell out certain legal aspects of the investment contract, including the capital call. New investors are advised to consult with people who have experience in the investment industry to make sure that they know all about the investments with which they are getting involved.