Committed, called and unfunded capital

Key takeaways

• The commitment is a legally binding promise to fund capital calls up to a stated amount, and the unfunded part of it is a real liability even though it does not appear as invested capital.
• The paid-in (PIC) ratio, paid-in capital divided by commitment, measures how far through its deployment a fund is from the LP's point of view.
• Unfunded commitment equals commitment minus paid-in capital plus any recallable distributions, so a recallable distribution raises what the LP may still be asked to fund.
• Recalled capital increases paid-in capital and therefore lowers DPI and TVPI compared with a presentation that nets the recall against distributions, so always check the convention.
• Exposure, NAV plus unfunded commitment, is the right measure of how much an LP has at stake in a fund, because the unfunded part can be called at any time.
• Overcommitment deliberately commits more than the target allocation because funds never have the whole commitment invested at once, but it must be stress tested against falling public markets and slower distributions.

The commitment: a promise with teeth

When an LP subscribes to a fund, it signs a subscription agreement and becomes bound by the limited partnership agreement. The key number in those documents is the capital commitment: the maximum amount the LP agrees to contribute when the GP calls for it. On day one the LP usually transfers nothing, or only a small first call. The rest remains a promise.

The promise is enforceable. LPAs set out the consequences of failing to meet a capital call, and they are designed to be severe enough that defaults are rare. Typical remedies include charging interest on the late amount, suspending the defaulting LP's share of future distributions, forcing a sale of its interest at a discount, or forfeiting part of its existing capital account. The exact remedies vary by LPA, so an allocator should read them, but the direction is always the same: a commitment is a liability, not an option.

The commitment is also the base for much of the fund's economics. During the investment period, management fees are commonly charged as a percentage of commitments rather than invested capital, so an LP pays fees on money it has not yet sent. And the fund's investment limits (for example, a maximum percentage of the fund in any one company) are usually expressed as a percentage of total commitments.

Capital calls and paid-in capital

A capital call (also called a drawdown) is a notice from the GP asking every LP to transfer its pro rata share of an amount by a due date. The notice states the purpose: a new investment, a follow-on, management fees, fund expenses, or repayment of a subscription credit facility that bridged earlier investments. Each LP's share is its commitment divided by total fund commitments.

Paid-in capital, also called contributed capital or called capital, is the running total of what the LP has transferred. Strictly, called capital is what has been requested and paid-in is what has arrived, and the two differ only for the few days between notice and payment or in the rare case of a default. In reporting they are used interchangeably.

The paid-in ratio, often abbreviated PIC ratio, expresses paid-in capital as a percentage of commitment. It is the cleanest single measure of how far through its deployment a fund is. A PIC ratio of 20 percent means the fund is early; 90 percent means nearly all the money has been drawn and what remains will mostly go to fees, expenses and follow-ons.

The fee base: commitment versus invested capital

Part of every capital call pays management fees, and the base on which those fees are charged is one of the most consequential links between commitment and paid-in capital. During the investment period, the most common structure charges the fee on committed capital. The LP therefore pays the full fee from the first close, even though most of its commitment is still unfunded. After the investment period ends, the base typically steps down to invested capital (the cost of investments still held, net of realizations and often of write-offs), sometimes with a lower rate as well.

This structure explains why early capital calls contain a relatively high share of fees and why net multiples start below 1.00x. It also explains why a slow-deploying fund is expensive for its LPs: every year the GP takes to invest the commitment is a year of fees on money that is not working. Some LPAs charge fees on invested capital from the start, which removes that drag but can give the GP an incentive to deploy faster than it otherwise would. Neither structure is universal, and the LPA's definitions of the fee base deserve a close reading.

For analysis, the practical consequence is that paid-in capital is not a clean measure of how much has been invested. Two funds with the same PIC ratio can have deployed quite different amounts into companies if one has a heavier fee and expense load. The capital account statement and the fee disclosures let the LP separate the two.

Unfunded commitment

Unfunded commitment, sometimes called uncalled or remaining commitment, is what the LP may still be asked to contribute. In the simplest case it is the commitment minus paid-in capital. The complication is recallable distributions, covered in the next section: if the LPA allows the GP to call back certain distributions, those amounts are added back to the unfunded commitment.

Unfunded commitment does not simply run down to zero. After the investment period ends, the GP typically loses the right to call capital for new investments but keeps the right to call for follow-ons in existing companies, fees, expenses and certain obligations. So a fund in year 8 may show several percent of commitment still unfunded, and a portion of it may never be called. Allocators often model the probability that late-life unfunded amounts are drawn rather than assuming all or none of it will be.

Recallable distributions

A recallable distribution is cash returned to LPs that the GP retains the right to call again. LPAs commonly allow it in a few situations: proceeds from an investment exited quickly (often within a stated window after purchase), return of capital from a bridge or warehoused investment, and sometimes an amount equal to management fees and expenses, so that more of the commitment ends up invested. This last use is often called recycling. The conditions, time limits and caps are set in each LPA and differ widely.

For the LP, recallability changes the nature of the cash received. A non-recallable distribution is finished business. A recallable one is closer to a temporary loan back to the LP: it can be spent, but the LP must be ready to return it. Good reporting shows recallable amounts separately in the capital account statement so the LP can track its true unfunded obligation.

Recallable distributions also create a presentation question for multiples. The standard treatment records the recall as a new contribution, which grows paid-in capital, and leaves the original distribution in cumulative distributions. Some reports instead net the recall against distributions, which leaves paid-in capital lower. The two methods produce different DPI and TVPI figures from identical cash flows, as the example below shows.

Exposure: NAV plus unfunded

NAV alone understates what an LP has at stake in a fund. The unfunded commitment is money the LP has promised to put into the same strategy, managed by the same GP, on the GP's schedule. Exposure (sometimes called total exposure or commitment exposure) adds the two together.

Exposure is the figure to use when asking 'how concentrated am I in this manager?' or 'how much private equity risk am I carrying?' Fund B illustrates the point. In year 1, NAV is only $3.7m, which looks small next to a multi-billion-dollar portfolio. But exposure is $24.7m, because $21.0m more can be called at any time. As the fund matures, NAV and unfunded trade places, and by year 6 exposure has fallen to $21.5m as distributions take value out of the fund.

Exposure can exceed the commitment. In year 3 Fund B shows exposure of $25.3m against a $25m commitment, because NAV ($14.8m) is above paid-in capital ($14.5m). That is not an error. It means the investments are marked above cost, so the LP's total economic stake is greater than the dollars it has promised.

Overcommitment

A private markets program has a target, usually expressed as a percentage of the total portfolio held in private assets at NAV. The problem is that a commitment does not become NAV one for one. Capital is called over several years, and distributions begin before the last call. So a single fund's NAV rarely reaches its full commitment, and it spends most of its life well below it.

Fund A from the previous topic makes the point. Its NAV peaks at $79m on a $100m commitment in year 5, and falls to $12m by year 10. An LP that committed exactly its $200m target to two funds like Fund A in the same year would see NAV peak around $158m and then decline toward $24m, never reaching the target at all. To actually hold the target at NAV, a program must commit more than the target, and keep committing every year. Committing more than the target NAV is called overcommitment.

The overcommitment ratio (or commitment ratio) measures how far a program has gone. Definitions vary; a common one divides total exposure (NAV plus unfunded) by the target allocation. A ratio of 1.0x means the LP has exactly enough exposure to reach target if every unfunded dollar were called at once and nothing were distributed. Above 1.0x, the program is relying on distributions from older funds to arrive before calls on newer ones.

Reading the capital account statement

Every quarter the GP or its administrator sends each LP a capital account statement. It reconciles the LP's position from the start of the period to the end, and it is where the figures in this topic come from. The ILPA Reporting Template standardizes the fee, expense and carried interest disclosures that sit alongside it.

The core of the statement is a roll-forward of the LP's capital account (its NAV): beginning balance, plus contributions, minus distributions, plus or minus the net result of the fund's operations (investment income, realized and unrealized gains and losses, minus management fees, expenses and any change in accrued carried interest), equals ending balance. Alongside it, the statement shows commitment, cumulative contributions, cumulative distributions (with recallable amounts identified) and unfunded commitment.

An LP should reconcile these figures itself every quarter. Paid-in plus unfunded minus recallable distributions should equal commitment. Contributions and distributions should match the LP's own cash records. And the net operating result should be explainable by the fee and valuation disclosures.