How money actually flows from VCs to startups

When a venture capital (VC) firm announces the close of a new fund, it doesn’t mean that the firm suddenly has millions of dollars sitting in its bank account. Instead, the fundraising comprises a series of commitments from limited partners (LPs) to inject their promised capital over the life of the fund.

Typically, VCs “call capital” from LPs over the life of the fund, depending on cash flow needs—like new investments or follow-on funding. But not every capital call is smooth or expedient; sometimes LPs delay or, in rarer cases, even rescind a wire after it has been sent. Issues like these, regardless of cause, can lead to a liquidity problem in the venture capital ecosystem that harms startups and slows innovation. 

While a capital call line may simply look like a debt instrument for VCs, there are a few distinct benefits.

The result is an administratively complex process that many managing partners would prefer to conduct at their own pace. One mechanism VC firms use to manage cash flow and ease the work of collecting from LPs is a capital call line of credit—also called a capital call facility—a specialized debt instrument made explicitly for VC liquidity. 

Speaking with BetaKit, Robert Rosen, Managing Director of Innovation Banking at CIBC, explained what capital call lines are, how they operate, and how liquidity instruments like these help keep Canada’s innovation economy moving. 

Understanding capital call lines of credit

When a VC firm needs money, it will “call capital” from LPs, requiring them to disburse a portion of the committed funds for use. Rosen noted this happens with differing frequencies depending on the individual fund, adding that it’s not uncommon to see annual, biannual, or quarterly calls.

“A fund, in essence, can make up to 10 or 20 capital calls over the life of its fund, which is typically 10 years long,” Rosen said.

A fund may also have capital needs in between calls: for instance, to fulfill a committed investment in a short timeframe or for a necessary expense, such as hiring a new team member. In these cases, calling capital from LPs may not be preferable—it can take 10 or more business days for funds to arrive even without additional human delays, which may not be quick enough for the deal or expense.

These short-term or urgent expenses are where capital call facilities can help. The amount a fund can access is typically based on a percentage of uncalled capital in the fund. From there, Rosen said payback periods usually range between 90 to 365 days, giving general managers plenty of time to call capital and clear the balance. 

“A capital call facility is effectively a line of credit to that fund to allow them to draw down on it, to make investments, or to allow the manager to manage the fund on a day-to-day basis without having to call that capital frequently,” he added.

How VCs benefit from capital call lines

While it might appear like a capital call line is simply a debt instrument for VCs, there are a few distinct benefits. The first is that these facilities contribute to the operational efficiency of the fund itself, ensuring that the general partner has the capital needed to run the firm without the administrative burden of frequently needing to call LP capital.

“It’s a lot of work to send out the request to call capital numerous times a year and then ensure that the money comes in, track it, monitor it, and all that sort of stuff,” Rosen added. “If they can do it efficiently, meaning fewer times a year, it’s a lot easier to manage.”

The second advantage is superior cash flow management, since these lines of credit ensure that the fund can always deposit money into portfolio companies on the promised date. This leads to a third benefit: reputation management. Not meeting capital obligations due to liquidity issues can lead to losing deals—or even losing your ability to fundraise in the future.

“If the fund is continually delayed or doesn’t meet the requirements that they have set out, both with their limited partners and with their portfolio companies, at the end of the day, they may not be able to raise another fund,” Rosen noted.

Even if the VC firm closes the deal in the end, Rosen added that a delayed deposit makes for an awkward start.

“The relationship between that founder and the fund isn’t going off on the right foot because everyone expected the money to come in on Friday, and it doesn’t, and it comes in a week later,” Rosen said. “…If you’re committing to closing a deal on a certain day and it doesn’t close, you get kind of a bad taste in your mouth.”

The start of a larger relationship

Beyond providing liquidity to VCs and thus the innovation ecosystem at large, Rosen said capital call facilities can be an avenue for building a relationship with a bank. This can lead to two downstream benefits for portfolio companies: the first is easier access to debt capital coinciding with the equity fundraise, which can increase a startup’s overall liquidity without further dilution. Second, is the possibility of a warm introduction to the bank as a potential customer.

But even if the capital call facility just provides liquidity, it’s still an important tool. As startups plan for—and rely on—committed capital from fundraises, high VC liquidity not only keeps fund operations running smoothly, but also enables the scaling potential of every portfolio company.

“Our goal is to support venture capital firms, number one, so that they can grow the ecosystem [and] Canada’s economy to make it more innovative and less resource reliant, because that’s effectively where the world is going,” Rosen added. “Number two, we’re here to assist individual companies with their growth aspirations.”