Committed Capital - Explained
What is Committed Capital?
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Table of ContentsWhat is Committed Capital?How does Committed Capital Work? Penalties for Committed Capital DefaultersManagement feesThe Bottom LineAcademic Research on Committed Capital
What is Committed Capital?
Committed capital is an agreement, based on a legal contract, between a private equity fund and an investor. The investor is then obligated to keep contributing money towards the private equity fund or the venture capital fund. The investor has the option of paying committed capital in a lump sum or make little contributions over a certain period of time. This may even take a couple of years. These terms of payment are usually in the agreement where both the investor and the private equity are required to sign.
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How does Committed Capital Work?
There are many directions in which the committed capital can take. The investor could partner with private equity and make contributions without having any investment plans at the time of investing. This is usually referred to as a blind pool because you don't know exactly what the money will do. This type of contribution is flexible because it allows investors to invest their money where there is a good opportunity. The internal rates of return (IRR) are higher with this kind of flexibility. Fund managers may be having a specific objective in mind at the time of investment.
Here the contribution amount towards the committed capital is decided by the funds manager. He or she then gives the exact amount that will be needed and the exact period of time that the investor has to make the contributions. This mode of committed capital is often preferred by many investors because it has a defined purpose. They also get time to align their set goals and their investment plans.
Generally, benefits of investing in committed capital may outweigh the risks, but investors should still be aware of the risks. The funds manager may have gotten a deal, but the available funds committed are not enough. This may force them to sell some of the assets they already acquired to meet the committed capital target.
Penalties for Committed Capital Defaulters
The investors are usually required to meet their end of the bargain depending on the terms in the contract with the private equity. If they fail to do this, then there may be severe consequences like penalty fees and payment of fines. Also, there is the possibility of investors being banned from future investment plans and interest being charged on the remaining amount.
The primary fund invested by the limited partners is usually charged management between 1.25% and 2.00%. Similarly, when the investor starts contributing towards the committed capital, there is a management fee that will be charged on the capital. This is to be paid regardless of the plan of the fund managers. Some private equity funds may only charge the management fee only on the capital that is invested and this is usually a little amount.
The general partners have a lot of different ways to generate funds from limited partners. This includes charging administration fees, placement fees, and transaction fees in some cases. The purpose of these fees is to take care of the overall expenses of the daily operations of the partners. Before investing in private funds, it is important for investors to analyze the fees associated with the investment. Ensure the fees are reasonable as a careful investment is always rewarding.
The Bottom Line
Co-investing is known to generate a lot of interests and profits. However, many are not skilled or equipped with the knowledge of making the process a success. Most importantly, investors need to understand the depth of the dynamics of committed capital and the required skills for both parties to be successful. Also, a business owner may sometimes be approached by potential financial buyers who want to purchase their business. The owner of the business needs to be extra smart to know what the accumulated committed capital can do. This will help to close the deal and determine if there will be a partnership between them.
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