A capital call line is a revolving line of credit that a lender provides to a private equity group (PEG). The line of credit is collateralized with a pledge of the right to call and receive capital contributions from the fund’s investors. Advances from the line are primarily used to bridge capital calls and for short-term working capital. To better understand, here is a review of the common terms associated with capital call lines:
- PEGs are closed-end investment companies that invest in businesses and/or commercial real estate.
- Investors in PEGs are typically high-net-worth individuals, institutions (such as insurance companies, pension funds and banks) and sometimes other PEGs.
- Committed Capital represents the amount of capital each investor pledges to invest in a PEG. This is contractual and the failure to fund a call of capital would result in a total forfeiture of the investment.
- Capital Contributions represent the amount of capital that has been called and subsequently invested by the PEG.
- Uncalled Capital represents the amount of capital that has been committed to but not yet used by the PEG.
A PEG raises capital by soliciting investors to commit capital, which is drawn over a specific period of time (5-7 years). The capital is used to acquire businesses (a real estate PEG would focus on commercial real estate). The PEG earns a return by investing in a business and increasing the value of the business over a five to seven year period and eventually selling or otherwise re-capitalizing its investment at a higher value.
The lender provides bridge capital to the PEG which is used to fund these acquisitions and bridge the time between the acquisition of the business and the call of and receipt of capital from the investors. The primary benefits are that the lender provides quick access to capital and a lower cost of capital. The cost of debt is almost always lower than the cost of equity. The advances on the line of credit are typically for 90-180 days at which time they are repaid with capital from the investors. The lender is secured with the uncalled capital of the fund. The Bank will typically advance 50-75% of the uncalled capital. Should an advance not be repaid in the allocated timeframe, the Bank has the right to step into the shoes of the PEG and call capital from the investors. If an investor does not honor the call then any previously invested capital is subject to forfeiture.
Here is a basic example to help explain how this works. Acme Investors raises $20 million of capital from a group of well-known high-net-worth individuals. Acme plans to acquire small businesses with the funds. Penske Bank knows Acme well and agrees to provide a $10 million capital call line of credit (50% of the uncalled capital). Acme identifies an acquisition for $5 million. It requests an advance of $5 million from Penske Bank. Penske advances the $5 million and the acquisition is consummated. Prior to the maturity of the advance (typically 90-180 days) Acme makes a capital call to its investors for $5 million. The proceeds are received and pay down the line of credit. Acme is left with $15 million of uncalled capital. Since the Bank will not advance more than 50% of the uncalled capital, the capital call line is reduced from $10 million to $7.5 million.
Capital call lines are a useful tool for PEGs and a win-win for banks too because they are a lower-risk profiled borrower, good depositors and may provide potential leads to finance their portfolio companies. Interested in learning more about capital call lines? The bankers at Univest Bank and Trust Co. can help. Please contact us at 877-723-5571 to be connected with a relationship manager.
Univest Bank and Trust Co. is Member FDIC, Preferred SBA and Equal Opportunity Lender.