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. The main benefit of having a capital call line or advice line is to bridge capital calls for short-term working capital.
To provide a better understanding, here is a review of common terms associated with
capital call lines:
● PEGs: Closed-end investment companies that invest in businesses and/or commercial real estate.
● Investors in PEGs: Typically, high-net-worth individuals, institutions (such as insurance companies, pension funds and banks) and sometimes other PEGs.
● Committed Capital: 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: The amount of capital that has been called and subsequently invested by the PEG.
● Uncalled Capital: The amount of capital that has been committed to the PEG but not yet used by it.
A PEG raises capital to acquire businesses by soliciting it from investors, such as institutions or ultra-high-net-worth individuals. The PEG earns a return by investing in a business over a five- to seven-year period, eventually selling or otherwise re-capitalizing its investment at a higher value.
A lender that provides a capital call line of credit gives additional capital to the PEG. This is used to fund acquisitions, as well as bridge the time between an acquisition and the call of and receipt of capital from investors. The primary benefits are that the lender provides both quick access to funds and a lower cost of them in order to close a deal. The cost of debt from a lender is almost always less 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 uncalled capital of the fund is used to secure the lender, and the bank will typically advance 50%-75% of it. Should an advance not be repaid in the allocated time frame, the bank has the right to step into the shoes of the PEG and call capital from investors for the repayment. 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 the process 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. ABC 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 and requests an advance of that amount from ABC Bank. ABC Bank advances the $5 million and the acquisition is consummated. Prior to the maturity of the advance, 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 PEGs typically have lower risk profiles, are good depositors and may provide potential leads to finance their portfolio companies.
However, some in our industry are pulling back from using capital call lines because it might not be the best use of capital — due to the fact that usage can be sporadic, and PEGs can sit on the funds for long periods of time. However, it’s something Univest continues to consider because capital call lines can fill an important need.
Interested in learning more about capital call lines? The commercial lending team at Univest Bank and Trust Co. can help. Contact us at 877-723-5571 to be connected with a relationship manager.
Univest Bank and Trust Co. is Member FDIC, Equal Opportunity and SBA Preferred Lender.