Committed capital
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Committed capital also called Commitments - it is an agreement between venture capital fund and an investor. Investor is being obligated to contribute a particular amount of money to the fund. This agreement is build on forms of contract. All the committed capital can be paid by the investor at one time or it may be spread over some period of time, usually committed capital is divided in parts which should be paid yearly (3-5 years). The committed capital can be used by the venture fund as a way to payoff investment or any fees. It is being made by summoning investor to make contributions when it is needed to be into the fund account. Certain time frames which have been agreed has to be respected within that call for contribution.
Types of committed capital
Committed capital may take various types. One of that type is so called “blind pool” agreement with a private equity fund. This type of investment is brings riskiness to the investor because his contributed money are being invested into purpose that he does not know of. On the other hand, this type gives huge advantage to the managers of venture fund, it brings flexibility, gives lead when opportunity will appear. Private equity market is considered much more riskier than the public equity, but higher risks brings higher returns.
When committed capital is being invested into specified, precise target the fund is obligated to make an call for particular amount of money, that gives investor the knowledge what for his money is invested and he can make a precise contribution. This type is the most commonly chosen one by the investor because it gives them chance to choose the fund that their want to cooperate with, adjust investment into their needs.
Types of penalties when agreement is breached
Failure to fulfill the agreement for committed capital carries several effects. When investor will not fit into with the contribution within the specified time frames the venture fund will probably impose penalties and fees that were included in the contract.
- Fines – Investor has to pay appropriate amount of money to the fund when he does not apply to the provisions of the contract
- Interest charges calculated on the basis of capital that investor ought to contribute. For example, If investor did not pay his contribution on time he looses 5% of his future return on investment
- Actions that may restrict or exclude future participation in the fund. Investor might get banned from taking part in future investments and get blacklisted.
- Investor might be obligated to sellout his part in the investment to other investors (Trémolet S. & Binderre D. 2010)
Examples of Committed capital
- A venture capital fund and an investor enter into an agreement in which the investor commits to contribute a certain amount of money to the fund over a three-year period. The investor will be obligated to pay the fund a certain amount each year for three years.
- An angel investor makes a commitment to invest $500,000 into a startup company over the course of five years. The investor will be obligated to pay the startup $100,000 each year for five years.
- A private equity firm makes a commitment to invest $10 million into a publicly traded company. The private equity firm will be obligated to pay the company $2 million each year over the course of five years.
Advantages of Committed capital
Committed capital is a form of agreement between venture capital fund and an investor. It has several advantages, such as:
- It allows investors to have a steady, predictable flow of capital into their venture capital fund which helps them to manage their investments better and plan their strategies better.
- It gives venture capital funds a reliable source of funds which they can use to invest in promising start-ups and other investments.
- It provides a degree of security to the investors as they know that their money is safe and they don’t have to worry about it being lost in the market.
- It also encourages investors to stay committed to the venture capital fund and make sure that their investments are being managed properly.
- It guarantees that the venture capital fund will have the money available when needed, allowing them to make quick decisions and take advantage of opportunities.
Limitations of Committed capital
Committed capital has some limitations which may act as a hurdle in the success of the venture capital fund. These limitations are:
- Illiquidity: Committed capital is not liquid and can not be converted to cash quickly as the investor is obligated to make written commitments.
- Time consuming: The process of raising committed capital is time consuming and involves a lot of paperwork. This can be a big hurdle for venture capital funds as they need to focus on investing instead of paperwork.
- Limited sources: The sources of committed capital are limited as only a few investors are ready to make long-term commitments.
- High cost: Committed capital is expensive as investors need to be compensated for the risk associated with their investments.
- High minimum investment: Committed capital has a high minimum investment, which can be a difficult hurdle for venture capital funds.
- Private Equity - Private equity is a type of capital investment that is typically provided by professional investors, such as private equity firms, to companies that are not publicly listed. Private equity investments are usually made in exchange for an equity stake in the company and are usually used for growth and development projects.
- Angel Investing - Angel investing is a type of venture capital funding that comes from individual investors. Angel investors typically provide capital to early-stage companies in exchange for equity or convertible debt.
- Venture Capital - Venture capital is a type of financing provided by a professional investor to a startup or early-stage business. In exchange for their investment, venture capitalists typically receive equity in the company they are investing in.
- Debt Financing - Debt financing is a type of financing where a company or individual borrows money in exchange for a promise to repay the loan over a specified period of time.
In summary, committed capital is but one of several approaches to financing a business. Other approaches include private equity, angel investing, venture capital, and debt financing. Each approach has its own pros and cons, and it is important for entrepreneurs to understand the differences and determine which approach is best suited for their business needs.
References
- Bodie Z., Kane A., Marcus J. A., (2008). Essentials of Investments (Seventh Edition)
- Burgel O., (2000) UK Venture Capital and Private Equity as an Asset Class for Institutional Investors. Research Report
- Kaplan, S. N., & Schoar, A. (2005). Private equity performance: Returns, persistence, and capital flows. The Journal of Finance, 60(4), 1791-1823. eilN
- Marti J., Balboa M., (2001). Determinants of private equity fundraising in Wester Europe. Social Science Research Network Working Paper
- Seitz N., Ellison Mitch., (1999). Capital Budgeting and Long-Term Financing Decisions (Third edition)
- Trémolet S., & Binderre D., (2010) Penalties for non-compliance – What penalties are most effective when the operator is in non-compliance with regulatory rules
Author: Grzegorz Szewczyk
