Capital Calls & Distributions: The Flow of Money

Alright, welcome back. Today we've got actually a good lesson planned out here from Lincoln talking about the flow of capital. So when investors come in, where does that money go? When money goes out, how does it all flow together? That's what we're gonna talk about in this episode. This is actually crucial. This is one of the, maybe the questions that you're scared to ask too.

Mm-hmm.

You think it's obvious, like, oh, and you're a little bit nervous to maybe bring it up on one of our live calls, and I was actually nervous the first time I started a fund to ask my dad or other mentors, just how does it actually work? Dumb it down for me. Let's get really simple here, and that's what we're going to do. We're going to talk about capital calls, distributions, and how those can change within a fund.

That's right. Okay, let's just start with the money, right? So let's call this Investor A, and he's going to put in $10 million, okay? And then Investor B is going to put in $40 million. Okay, what happens to that money? Now, obviously, there's soft commitments, which we teach, like go out and go raise this money, just get— see if there's proof of concept, right? You don't take the money into custody then. And then you go sign, you know, your LP, you get your docs all set up, your LPA, your PPM.

You get sub-docs, they sign those sub-docs.

You still don't take the money into custody. Okay, they keep the money there. They have custody over the funds, but you then have discretion.

Okay, meaning so you now have just a contract, a piece of paper that says I can call $40 million whenever I'd like from Mrs. Investor B right here. That's all your contract says, and that helps on your liability as well. You do not want to take the money before You need it. There could be embezzling, you could have an employee steal it. You don't want to have that liability. They keep the money in their account until you need it.

Right. And that also helps like with calculating your return, right? Because you're only accountable to the funds that you have in custody, right? Your IRR clock starts ticking once you take that money. So once you're ready to call that capital, where does the money actually go? Okay, we're going to have 2 bank accounts here, the GP bank, and then you're going to have the LP bank. Now, your GP bank is just your regular bank account, right? It's usually in an LLC, okay? You're going to go apply. It doesn't really matter. Like, this is just for expenses, right? What else do you pay for out of a fund?

Depending on your fund structure, you might pay for employees out of here. It could be your IA or RA pays for that as well, but office space and other stuff. This is just general, your business that you're running. Most banks should be just fine holding your general partner bank account.

No, when you go and apply for this GP bank account, you're going to need like an EIN or a TIN as well as just proof of entity, right? Like an LLC operating agreement.

Articles of incorporation, the state.

Yeah, something like that. Okay, now the limited partnership bank account is a little different, right? This is where the funds are actually held, and banks get a little stingy sometimes. So we just wanted to give quickly like recommendations on which banks are good to work with depending on what type of fund you're in.

When I started my first fund, I was actually surprised. I went to Chase and I went to all these big banks, Wells Fargo, and they would turn me down. They did not want to take my money. They didn't want my business. And I was a little bit— I didn't even realize that was an issue, is that some banks do not even want to deal with funds.

So I actually called around to a bunch of different banks and asking them, you know, what's the best way to work with them and what you need. Essentially, what I came to do with was this: is that KeyBank's best to work with for real estate. You know, they have their methods all figured out and proof of funds concept, whatever. PacWest is really good for venture capital or private equity funds, and UBS is really good for hedge funds. Now, this is solely bank accounts, right? PacWest does do lending on those accounts if you're trying to get some leverage in a private equity or VC fund, but but mainly it's just for servicing. You know, these types of entities.

Additionally, one more I'll add is Silicon Valley Bank. They really like to work with funds and fund managers, more primarily with venture capital, private equity, and some hedge funds work there as well.

So you got your bank accounts set up and you've got your deal, right? We're going to call this ABC Co. All right, so you've got this company you want to invest in, and let's say it's $5 million. All right, the price of this. So you're going to call your capital down pro rata. We use that term a lot. It seems like a lot of people don't understand. It just means in proportion to. So essentially, from Investor A, you're going to take $1 million, and from Investor B, you're going to take $4 million. So that's 10% of the total capital that they committed, and that gives you $5 million, right? Enough to invest into this So you're going to call the capital, put it into your LP bank, and then obviously there's a little bit of wait time, but you then have the funds in your custody, and then it's ready to, you know, buy, you know, whoever you're paying out this money to, to acquire this company or property or investment, whatever it is.

So typically I've seen with the timing of this, sometimes it gets a little hard because ABC Corp wants to close on this Friday, but you need to notify investors. I've typically seen, you You give investors 10 to 14 days to fulfill their capital calls, meaning they need to send their $4 million or $1 million to your bank account, and you send them wire and routing instructions. If they do not, your LPA and PPM will have some type of penalty on their capital or capital commitment from them. That'll be disclosed in your documents. So 10 to 14 days, that money comes in, and now it's in your bank account. You can go and close. As you grow and get bigger, some of these banks will give you and issue you lines of credit Just for that waiting period. They're 10, 14, maybe 21-day lines of credit, just so that when capital calls are being fulfilled, you can still close on ABC Corp this Friday and you won't miss deals. That's something you can negotiate with your banks as you get started.

Obviously, the more money you have, the more leverage, right? Now let's talk about timeline, right? So holding period of this and what that actually looks like. So, you know, year 0 is when you're kind of doing all this stuff, collecting, raising the money, getting everything set up. It depends on what type of fund. For hedge funds, you kind of deploy capital right away. It doesn't have to be that way, but within the first 6 months of operating.

Mm-hmm.

But for most other funds like venture capital, private equity, and real estate, it's usually a 2 to 3 year investment period, right? Where this is kind of like the deployment period. where you're finding deals, allocating the money, and investing. Okay? And then this other period, anywhere between, I don't know, 4 to 10 years, right? Depending on the life of your fund, this is more of the harvesting. Now, Bridger, talk to us about how would you think about paying out this money? Do you want to pay it out all in a lump sum in year 10? Do you want to do it a little bit in year 3 through 5? And what does that all look like?

Now again, back to what you were saying, it depends, right? It depends on what you're doing. But let's talk through a private equity or real estate fund that's going to be buying large assets and then selling them. They typically will, by year 3, they are hoping to be 100% deployed. Meaning we've got $50 million here, we're hoping in the first 3 years we can deploy all $50 million into deals. By year 4, 5, maybe we're upgrading those companies or we're value-add to our real estate, we're letting those season. By year, maybe you can put down year maybe 6 or 7, we're going to start looking at exiting those deals. Now, what I've seen typically in funds is when they begin to exit— let's say in this fund you've purchased 10 deals, maybe on year 5 you exit your first deal. What I've seen is most investors— you, let's say it's ABC Corp we bought, we exit ABC Corp, we sell it for a great profit, or maybe we IPO'd, we had this great exit, right? The money from the exit will flow back to the LP bank account here. This is where it will flow, and then from there you can do one of two things. First thing you could do, you could hold the money or maybe invest in other properties or other businesses, whatever your fund's doing, or you distribute back to your investors. Typically, I've seen the latter happen because as a fund manager, some of these investors have waited. 4 or 5 years to have a distribution. They're like, man—

They want to see money.

What's Lincoln and Bridger doing? Are they just sitting on their hands? Are they actually investing? What's going on? It's one of the best days of your life, for me at least, running a fund, is when I send my investor a fat check. I love to send them a check. I write them out an email or whatever report we're going to send them, and it's like, man, I just got you a huge return. And I know that investor is smiling on the other side of the world like, Man, Bridger did a great job with my money. I would potentially like to maybe invest with him in the future. And it just is a great feeling with what you're doing. So typically I've seen the latter. Most fund managers will distribute most of the returns they get back. Now you gotta save some for taxes and other things like that, but that money flows back to the investors there.

Okay, so you pay back your money, and then of course you wanna take a cut of that as well, right? You pay back— after you pay back your investors. So your performance fee is going to go to the general partnership, right? And your RIA is going to take the management fee. And kind of a note on that as well, it's typical for the management fee only to be charged in the years where you're deploying the capital, especially for private equity and venture capital. If there's a lot of maintenance and stuff that needs to happen, then, you know, you can charge management fee throughout the whole time, but it's usually only collected in these first couple of years.

And that's something you guys can determine when you're putting together your fund docs.

Yeah.

A note here on RIA versus IA. Investment advisor is under $150 million. Registered investment advisor, now you're at the SEC level, is when you get over $150 million AUM. Those are the difference there. We have other videos that talk about that. So that split happens. We also have other videos that talk about how to actually exactly do that split. We're not going to talk about that here. But whether you do an American waterfall or a European waterfall will also determine how that splits down. Again, other videos. We won't talk about that here, but that split will happen here. But that's when you are selling or exiting or disposing of these deals. Typically in this time of a timeline, maybe year 5, 6, or 7, you start exiting these types of deals. Now your IRRs are calculated usually in a fund, they backdate for the entire time period that that money has been deployed. So for ABC Co., if you bought it on year 2 and you sold it on year 7, you would have 5 years to calculate back your IRRs on. So if that ABC Co. got 100%, you doubled your money, right, in 5 years. You doubled your money, great. Your IRR or yield in that case, just simple math, I'm not going to go into the complexities of IRR right now, but would be a 20% per year split because it took 5 years to double your money. So that's, you'll have to backdate the timing on when you purchased the original assets.

And just so you're informed, like while the investor's waiting, they're not usually keeping their money in just a bank account ready to go, right? They still want their money to make money. So it's usually in some sort of money market account or even just very liquid public investments like a mutual fund or some sort of indices that's, you know, has a high volume that they can get out of quickly if they need to. So your capital calls and your distributions, right? When the money's paid back, it's your distribution. And you need to really reverse engineer your deal and your fund, right? And thinking about how often you make distributions. Venture capital, like you're waiting for that money to ripen and season. You're probably not gonna have any distributions here, right? But if you're flipping real estate and you can buy and sell a property in 6 months or 18 months, you don't want to have a distribution every couple years, right? You want to do that semi-annually or even quarterly or annually, like whatever makes your investors happy. It comes back to your ability to Reinvest that capital, and if you can't, then just set expectations that you're gonna give that money back to them.

Yeah, maybe we can erase this for a second and just share examples for other types of funds. That would be for a long 10-year closed-ended funds. Inside of a hedge fund, if you've got a 1-year timeline here and your hedge fund is trading or whatever you're doing, and let's say this is 1 year right here, you might do like Lincoln was saying, maybe every 6 months or at a 1-year mark, what you do— let's say your fund started at X and it grew and grew and grew, and now it's up here. I've seen a lot of funds where they will sell off here and they will go back to their basis, maybe it's every 6 months or every year, and distribute those returns to their investors. Some hedge funds, maybe they do it every 2 years or every 3 years, they can have a longer— it really comes down to your investment thesis and just being smart with how your capital is moving. If you're a day trader, this probably makes a lot of sense. If you're a long-term buy-and-hold type of trader, This probably wouldn't make sense on a 6-month, maybe it's a 2-year or a 5-year timeline. It really depends on what you're doing. Like Lincoln mentioned, real estate example of flipping, if you're flipping houses every 90 days, well yeah, send some distributions to your investors every, maybe it's every 6 months, maybe it's once a year. My fund currently, to give you another example, I distribute every single month. We do small microloans that are fast, they turn over about every 3, 4, 5 weeks, so I make profits consistently every month. every month and I make distributions, I try to, on a monthly basis. Again, back to your fund and your concept, you've got to make a distribution schedule that makes sense with how you're investing. And again, it doesn't matter. I don't think investors will be mad one way or the other. It really comes down to their expectations when they signed up for this fund. If they signed up for the fund and they signed all this stuff and they're expecting a distribution every 6 months, that's what you told them, But they only get one maybe a year and a half later and then 2 years, they're going to be like, what the heck? I thought I was going to have it every 6 months. But if you tell them the expectation, hey, we expect to distribute in maybe year 4, 5, or 6 from now, okay.

Yeah.

I can sit, I can wait, that's my expectation. It's all about meeting investors' expectations when you're thinking about distributions.

And just design it so where it fits your deal, right? If you don't think you're going to have any money to distribute in the first 3 years, then tell them that, you know? We're not gonna pay out any distributions in the first 3 years, but then once our deals start harvesting, we're gonna pay out every 6 months after that. Just whatever makes sense for your investments.