Calling capital for an SMB acquisition

Calling capital is a term often used by private equity funds, real estate sponsors, and venture funds to describe when general partners (GPs) of the project start reaching out to limited partners (LPs) to fund their equity commitments to the project.

For small business entrepreneurs using investors to help fund the acquisition or recapitalization of a business, they will often need to run a capital call as well. 

General Flow of Calling Capital

Unless an entrepreneur is running a traditional search fund, which has committed capital prior to an acquisition target under contract, most of the time investors are first engaged with materials once a deal is under contract.

The order of operations typically includes the following:

1. Receive a Term Sheet for a Bank Loan: Shortly after going under contract, searchers should reach out to loan brokers or direct to lenders to get a term sheet for the deal. This term sheet derisks the chance that the deal struggles to get debt financing and helps fill in the blanks on interest rate, closing costs, etc.

2. Begin to Circle Investors: Once the deal has a term sheet from a lender and the initial pass of due diligence checks out, the next step is to begin circling investors as due diligence or the quality of earnings proceeds. 

3. Formalize Your Equity Raise: As you discuss the capital raise with investors, you will begin to formalize the terms of the equity raise, create a process for reaching out and managing investors, and get drafts of the investment docs and deck.

4. Get Equity Commitment Letters: As you drive investors through your process, you will collect equity commitment letters along with your term sheet that specify how much money an investor is committing to fund.

5. Complete Underwriting with the Bank: Once you have a majority of the round committed, the bank will normally begin the final stretch of underwriting. Most banks are hesitant to engage in full underwriting until they are reasonably confident that investors will materialize.

6. Call Capital: As the bank finalizes underwriting, they will ask for the equity to be funded. This is when you will call capital from your committed investors. Depending on the bank, the funds may be deposited with an attorney, the bank itself, or the acquisition entity’s operating account.

7. Close the Deal

What’s Involved in Calling Capital?

When a searcher is reaching out to investors to call capital, typically she will send a notice a week or few weeks in advance to allow the limited partner time to gather their funds and wire those funds to the bank account that is owned by the fund. Along with the notice for a capital call, the searcher will send wire instructions and confirm wire instructions.

Why Do Investors Not Immediately Fund the Round?

Small business investors don’t deposit all of their contributed capital at the time of committing because limited partners and investors in general prefer to control their own money and only contribute capital when the deal is certain to close. 

By delaying funding, the investors can continue to keep their funds in other investments that are likely generating interest or passive income, unlike a checking account at a bank.

In short, limited partners keep their capital because otherwise they lose out on additional returns they could earn with that capital.

What if a Deal Needs Cash Prior to a Capital Call?

For more sophisticated vehicles, there are often capital call lines of credit available for a fund to pull from banks or other lenders that allow the fund to continue on with operations and/or the acquisition until the capital call funds have come in from limited partners.

For SMB acquisitions, this isn’t necessarily true, which leaves the self-funded searcher and future manager of the acquired business responsible for funding any cash needs in the interim.

Overall, calling capital for SMB acquisitions is quite similar to how capital is called for real estate projects. 

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.