There is no such thing as too many investors. You just can’t have enough. But with different investors joining the fund on different dates, keeping track of your investor allocations can get tricky. To keep it simple, most venture capital and private equity funds perform an equalization (also known as investor close) when onboarding new investors.
Let’s see how this works.
The Initial Close ?
Suppose your fund did its initial close of $10mn with two investors on 1st January, 2019. The capital commitments were as follows:
|Investor||Commitment ($)||% Ownership|
To make investments and charge set-up costs, you called $1mn.
|Investor||Drawdowns ($)||Uncalled Capital ($)|
The Second Close
With your continued fundraising efforts, you get Carol to commit $2.5mn to your fund on 31st March. Your investor allocations now looks like below:
|Investor||Commitment ($)||% Ownership||Drawdowns ($)|
Something doesn’t seem right. Alice and Bob have paid 10% of their commitment with Carol paying nothing at all!
An easy solution would be to ask Carol to pay $250k to balance things out. However, doing so will leave excess money in your bank account and eat into your IRRs.
Here's when equalization comes into play.
The Magic of Equalization
Equalization is all about asking the question ”what if Carol had joined at the time of initial closing?”
She would have paid her share of the $1mn i.e $200k, with other LPs paying accordingly.
|Investor||Commitment||Actual Drawdowns||(Returned) / Called)||Adjusted Drawdowns||% drawn (post-equalization)|
To equalize, we simply call the deficit from Carol and distribute to other partners.
But that's not all. Because Carol joined late but participates in all investments made before the 2nd close, it's only fair that she compensates initial investors. This compensation is popularly known as equalization interest
How to calculate Equalization Interest?
Let’s assume that the fund charges 8% annually to incoming LPs as equalization interest. Carol will then pay an 8% interest on the amount she was due to pay on 1st Jan ($200k) but paid on 31st March. ?
The interest can be then distributed proportionately between original investors as compensation for providing excess money to the fund for 3 months.
|Investor||Commitment ($)||% Ownership||Interest ($)|
Seems easy, right? Imagine a scenario where you record multiple capital calls and onboard multiple investors between two closes, or a scenario where you raise follow-on commitments from your existing investors. The calculations can easily snowball from a single table to multiple complicated excel spreadsheets.
With Fundwave, make your equalizations a breeze. Churn out notices and journals at a tap.
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