Capital Commitment

Capital Commitment
See also

Capital Commitment is a number of funds, which investors provide in case of investment. The investment in venture capital and the buyout is restricted to the institutional investors and wealthy private individuals or family offices, which become limited partners with their investment, in case of the structure of the fund is characterized as a limited partnership. During the fundraising, they provide the committed of funds. The money, which is committed, is called committed capital. Capital commitment is particularly important to the functioning of markets where buyers and sellers arrive sporadically and search costs are relatively high[1].

Pros and cons of using capital commitment

There is a huge variety of the pros and cons of using a capital commitment. It is necessary to consider them before the decision of capital commitment will be taken[2][3].

Advantages Disadvantages
  • increasing liquidity and financial efficiency,
  • commitment mechanism allows the banks to commit to a higher future price level through current currency depreciation,
  • provides support to escape from a liquidity trap,
  • commitment strategy helps gain knowledge capital,
  • there is no need to keep up with costs of servicing bank loans or debt finance,
  • some venture capitalists can bring valuable skills, contacts, and experience to a business,
  • investors can help in making key business decisions,
  • it helps to develop the enterprise,
  • increases the satisfaction and self-fulfillment of managers as new projects are created, thanks for capital commitment,
  • there is a huge risk connected with an uncertain investor,
  • because of a small mistake it is easy to lose liquidity,
  • raising equity finance is demanding, costly and time-consuming,
  • potential investors need to have meticulous information about the company's financial history, past results, and forecasts. Preparing this information takes lots of time,
  • there are problems with legal issues and regulations,
  • investors make some decisions, and the company's owners cannot change them,

References

  • Bessembinder H., Jacobsen S., Maxwell W., Venkataraman K. (2018), Capital Commitment and Illiquidity in Corporate Bonds, "The Journal of Finance. The Journal of the American Finance Association", vol. 73.
  • Farhi E., Sleet Ch., Werning I., Yeltekin S. (2012), Non-linear Capital Taxation Without Commitment, "The Review of Economic Studies Advance Access", vol. 20.
  • Gregoriou G. N. (2008), Encyclopedia of Alternative Investments, CRC Press, New York.
  • Jeanne O., Svensson L. E. O. (2004), Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank, International Monetary Fund.
  • Kent Baker H., Filbeck G., Kiymaz H. (2015), Private Equity: Opportunities and Risks, Oxford University Press, New York.
  • Lu Q. (2007), Long-Term Commitment, Trust and the Rise of Foreign Banking in China, Chandos Publishing, Oxford.
  • Marin M. (2017), Connected by Commitment: Oppression and Our Responsibility to Undermine It, Oxford University Press, New York.
  • Mayer C. (2013), Firm Commitment: Why the corporation is failing us and how to restore trust in it, Oxford University Press, United Kingdom.
  • McMurray A.J., Pirola-Merlo A., Sarros J.C., Islam M.M. (2010), Leadership, climate, psychological capital, commitment, and wellbeing in a non-profit organization, "Leadership & Organization Development Journal", vol. 436.

Footnotes

  1. Gregoriou G.N. (2008), p. 63
  2. Kent Baker H., Filbeck G., Kiymaz H. (2015)
  3. Bessembinder H., Jacobsen S., Maxwell W., Venkataraman K. (2018)

Author: Milena Kurczek