2.2 Commitments, capital calls and distributions

When an LP commits to a private equity fund, it does not hand over the money up front. It makes a promise to pay when asked, and it gets money back only when the fund sells companies. The timing of these cash flows drives much of the work in fund operations, treasury and investor relations.

For LPs, it creates a planning problem. They need cash ready for calls they cannot predict exactly, and they must wait years for money to come back. This lesson follows the cash through a fund's life, using the course's fictional fund, Ashcombe Capital Fund I.

Commitments

A commitment is an LP's legal promise, made in the limited partnership agreement (LPA), to provide up to a set amount of money to the fund over its life. Ashcombe Capital Fund I has $100m of total commitments (illustrative).

At any point, an LP's commitment splits into two parts:

• Contributed (or paid-in) capital: what the LP has already paid in.
• Unfunded (or undrawn) commitment: what the GP can still call.

Each LP's share of the fund is set by its commitment. An LP that commits $10m to a $100m fund has a 10% share. It pays 10% of every capital call and, broadly, receives 10% of what is distributed to LPs.

Commitments are binding. If an LP fails to pay a call, the LPA commonly sets out tough penalties for a defaulting LP. These can include charging interest, forcing the sale of its interest, or cutting its share of the fund. Defaults are rare, precisely because the consequences are serious.

Capital calls

A capital call (also called a drawdown) is a request from the GP for LPs to fund part of their commitment. The GP calls money when it needs it, rather than all at once, so that LPs' money is not sitting idle in the fund.

A capital call notice typically states:

Item	Example
Total amount called	$25m across all LPs
This LP's share	$2.5m for an LP with a 10% share
Purpose	New investment, management fees, fund expenses
Due date	Commonly around 10 business days after the notice
Payment details	The fund's bank account and a reference

Calls are used for three main things: buying companies, paying the management fee to the manager, and paying fund expenses such as legal and audit costs. Most calls happen during the investment period, commonly about the first five years. After that, the GP can usually call only for fees, expenses and follow-on investments in companies the fund already owns.

Behind each notice sits a lot of operational work. Fund accounting calculates every LP's share, checks it against side letter terms such as fee discounts, and issues the notices. Once the due date passes, the team matches incoming payments to each LP and follows up on anything missing. On the LP side, treasury teams keep enough cash or liquid assets on hand to meet calls when they arrive.

Many funds also use a subscription credit facility, a short-term loan to the fund secured on LPs' unfunded commitments. It lets the GP buy a company quickly and call capital from LPs a little later, or in fewer, larger calls. It changes the timing of cash flows, which matters when lesson 4.2 looks at performance.

A fund rarely calls 100% of commitments. Some money is held back for fees and follow-ons, and once the investment period ends, the rest usually goes uncalled.

Distributions

A distribution is a payment from the fund to its partners. In private equity, most distributions come from exits: selling a portfolio company, or part of one. Some also come from dividends or refinancing proceeds paid by portfolio companies.

Suppose Ashcombe sells Northfield Components and the fund receives the proceeds. The GP works out how the money is split using the distribution waterfall in the LPA. Broadly, LPs first get back what they paid in, and then profits are shared between LPs and the GP. Lesson 2.3 works through a waterfall step by step.

Two points often confuse newcomers:

• Distributions do not restore the commitment. Once money is returned, the LP's unfunded commitment does not usually go back up.
• Some distributions are recallable. Many LPAs let the GP recall certain distributions, for example money returned soon after it was called. A recallable distribution adds back to the unfunded commitment. Operations teams track this carefully, because it changes how much each LP can still be asked to pay.

A fund's life in cash flows

Here are the cash flows for Ashcombe Capital Fund I over its 10-year life.

The following example is illustrative. Figures are in $m, at the end of each year. Called capital includes management fees.

Year	1	2	3	4	5	6	7	8	9	10
Called	20	25	20	15	5	0	0	0	0	0
Distributed	0	0	5	10	20	30	35	25	15	10
Net cash flow to LPs	−20	−25	−15	−5	+15	+30	+35	+25	+15	+10
Cumulative	−20	−45	−60	−65	−50	−20	+15	+40	+55	+65

Reading the table:

• Net cash flow is distributions minus calls, from the LPs' point of view. In year 3, LPs paid in $20m and received $5m, so the net figure is −$15m.
• Cumulative is the running total of net cash flows.
• Total called over the life is $85m. The fund never called the other $15m of commitments.
• Total distributed is $150m.

Each LP sees its own slice of these figures. An LP with a 10% share would pay $8.5m in calls over the fund's life and receive $15m in distributions, with its own cumulative position bottoming out at −$6.5m in year 4. Its unfunded commitment would fall from $10m to $1.5m by the end of year 5 and stay there. Fund accounting teams produce these figures for every LP, and LP-side analysts use them to forecast how much cash they will need to keep ready.

The calls come early, in years 1 to 5, while the fund is buying companies. The distributions build from year 3 as the first companies are sold, peak in year 7, then taper off as the last holdings are exited.

The J-curve

Plot the cumulative line on a chart and it traces the shape of a letter J, tilted on its side. This is the J-curve.

Stage	Years	Cumulative position
Going down	1–4	Falls from −20 to its lowest point, −65, at the end of year 4
Climbing back	5–6	Rises to −50, then −20, as exits begin
In positive territory	7–10	Crosses zero in year 7 (+15) and ends at +65

Why the dip? In the early years LPs pay for investments and fees, but the companies have not been sold yet. Value is being created, but it has not turned into cash. The J-curve also appears in reported returns. Fees and costs hit early, while gains on companies are often recognized only gradually, so early performance figures can look weak.

The J-curve matters in practice:

• LPs plan their cash. They must keep enough liquid money to meet calls in the early years, even though the fund will eventually pay back more.
• Early numbers mislead. A young fund with negative figures is not necessarily a bad fund.
• Speed changes the shape. Faster calls or slower exits deepen the curve; subscription lines and quick exits make it shallower.

Lesson 4.2 measures how well this fund did, using performance measures such as multiples and IRR.

Key terms

• Commitment: An LP's legal promise to provide up to a set amount of money to the fund over its life.
• Contributed (paid-in) capital: The part of a commitment an LP has already paid.
• Unfunded (undrawn) commitment: The part of a commitment the GP has not yet called.
• Capital call: A request from the GP for LPs to fund part of their commitment.
• Defaulting LP: An LP that fails to pay a capital call, which triggers penalties under the LPA.
• Subscription credit facility: A short-term loan to the fund, secured on LPs' unfunded commitments, used to bridge or delay capital calls.
• Distribution: A payment from the fund to its partners, usually from exits.
• Recallable distribution: A distribution the GP may call again, which adds back to the unfunded commitment.
• J-curve: The pattern of early negative, then positive, cumulative cash flows (and returns) over a fund's life.

Key takeaways

• LPs commit a fixed amount, and the GP calls it pro rata over time, mostly during the investment period.
• Capital call notices commonly give around 10 business days to pay, and defaulting carries serious penalties.
• Distributions come mainly from exits and are split using the LPA's waterfall.
• Funds rarely call all their commitments; the illustrative Ashcombe fund called $85m of $100m and distributed $150m.
• Early calls and later distributions create the J-curve: Ashcombe's cumulative cash flow bottoms out at −$65m in year 4 and turns positive in year 7.