Cash-flow mechanics

Capital call

A binding demand on each LP for its pro rata share of an amount the fund needs, with a stated purpose and a stated funding date. The LP's obligation is contractual and is not conditional on the LP's view of the investment.

Field	Value
Formula	LP's share = call amount * (LP commitment / total commitments), adjusted upward for any excused or defaulting LP's reallocated share
Worked	An LP with a 25.0 commitment on a 500.0 fund funds 5.00 percent of every call. The year-1 call of 119.30 costs it 5.9650
Over the fund's life	5.00 percent of 500.0 = 25.0, called across ten years, of which 0.9350 is called after the commitment period ends
Peak year	The largest single call is 119.30 in year 1, being 23.86 percent of commitments. An LP must hold liquidity against that, not against the average
Purposes	Of the 500.0 called, 425.0 funds investments, 66.2 funds management fees and 8.8 funds partnership expenses

• The notice period is the LP's real constraint, not the total commitment. A ten-business-day notice on a call worth 23.86 percent of commitments requires cash or a committed facility, and it will arrive without warning.
• Calls after the commitment period are the ones LPs most often fail to plan for. On the reference fund 18.70 is called in years 6 to 10, none of it for a new investment, and it arrives when the LP has mentally closed the position.
• Read the stated purpose on every notice and keep a running total by category. A call for fees when the fee base should have stepped down is the most common and most easily recovered fee error, and it is only visible from the notices.

Equalisation of a subsequent closer

The mechanism placing an LP admitted at a later closing in the same position as the first-close LPs. The late LP contributes its share of prior calls, plus interest for the period the earlier LPs' money was outstanding, plus management fee for the period since the fund's start.

Field	Value
Formula	Catch-up = (cumulative calls / first-close commitments) * late commitment. Equalisation interest = catch-up * r * average age of the prior calls. Backdated fee = fee rate * late commitment * elapsed period
Setup	First close 400.0; subsequent close 100.0 nine months later; 75.0 called before the subsequent closing, being 18.7500 percent of first-close commitments
Worked	Catch-up 18.7500; interest 18.7500 * 0.08 * 0.50 = 0.750000; backdated fee 2.00 percent * 100.0 * 0.75 = 1.500000; interest on the fee 0.045000. Total 21.045000
Who receives the interest	0.795000 goes to the first-close LPs, being 0.198750 percent of their commitments, unless the LPA directs it to the fund instead
Check	After admission both groups have paid in 18.7500 percent of their commitments: 75.0 on 400.0 and 18.7500 on 100.0

• Two things vary between agreements and both are worth reading: the rate, and whether the interest is paid to the earlier LPs or retained by the fund. Retention by the fund converts a payment between partners into a reduction of the fund's expenses, which is not the same thing.
• The average age of the prior calls is an approximation in most documents and an exact calculation in a few. On a fund with a large early call the approximation understates what the late LP owes, and the amount is small enough that nobody argues.
• The backdated management fee is the larger of the two components here - 1.500000 against 0.750000 - and it is the one a late investor most often does not expect. An LP negotiating admission at a later close should confirm whether it pays fee from the fund's inception or from its own admission.

Paid-in against drawn, and why they can differ

Drawn capital is what the fund has called. Paid-in capital is what the LPs have actually paid. They diverge when a call is outstanding, when an LP is in default, and permanently when the LPA treats a recalled distribution as reducing paid-in rather than adding to it.

Field	Value
Formula	PIC = cumulative calls - amounts unpaid + amounts recalled and refunded, subject to the LPA's recallable-distribution convention
Worked, base case	Reference fund: cumulative calls 500.0 and paid-in 500.0. They agree because no call is outstanding and no distribution was recalled
Worked, with a recall	Recall 100.0 in year 7 and the two figures separate: drawn becomes 600.0 while paid-in stays at 500.0 under the netting convention
Effect on every ratio	DPI of 1.8560x on the netting convention against 1.7133x on the gross convention, from the same cash

• This is the most common source of an irreconcilable set of published multiples. Two managers can report DPI on the same cash flows 0.1427x apart with neither of them stating a convention, and no reader can detect it from the report alone.
• The check is simple and rarely run: ask for cumulative calls and cumulative paid-in as separate lines. If they differ, ask why, and the answer will name either a default or a recall.
• An LP building its own performance record should compute everything from its own bank statements rather than from the manager's capital account statement. The bank statements have exactly one convention.

Source: ILPA Reporting Template distinguishes cumulative contributions from paid-in capital and requires recallable distributions to be disclosed.

Recallable distributions

Distributions the LPA permits the GP to call again. They are the mechanism through which recycling operates, and they mean an LP's unfunded commitment is not simply commitments less calls.

Field	Value
Formula	Effective unfunded commitment = (C - cumulative calls) + recallable distributions outstanding, capped by the recycling limit
Worked	At the end of year 7 the reference fund shows 7.20 of unfunded commitment. With a 20 percent recycling right and 450.0 already distributed, the effective unfunded commitment is 7.20 + 100.0 = 107.20
As a share of the stated figure	107.20 against 7.20 - the LP's real remaining obligation is fifteen times the number on the capital account statement
What makes a distribution recallable	Commonly a return of capital rather than profit, within a stated period, and up to a stated percentage of commitments

• This is the single largest gap between the unfunded commitment an LP reports internally and the amount it may actually be asked for. A liquidity model built on commitments less calls understates the obligation by the whole recycling capacity.
• The three limits to check are the percentage cap, whether the right survives the end of the commitment period, and whether it applies to distributions of profit as well as of capital. A right limited to returns of capital within the commitment period is a modest term; one extending to profit for the whole term is not.
• Recallable distributions also break the intuition that DPI is monotonic. A fund's DPI can fall from one report to the next without any write-down, simply because cash came back.

Distributions in specie

A distribution of securities rather than cash, usually shares in a portfolio company that has listed. The fund records the distribution at a stated valuation and the LP receives an asset it must sell itself.

Field	Value
Formula	Distribution recorded = shares * valuation on the distribution date. LP realised proceeds = shares * price achieved, less transaction costs and any lock-up effect
Setup	60.0 of the 310.0 realised on investment C in year 7 is distributed as listed shares
Worked	A 20 percent fall before the LP can sell reduces the value received to 48.0 while the fund still records 310.0. The LP's actual year-7 receipt is worth 298.0
Effect on DPI	The fund's DPI is struck on the distribution-date value in every case. The LP's own DPI, computed from proceeds, is not

• The valuation convention is the whole term. A distribution valued at the closing price on a single date, of a stock the LPs collectively cannot sell in a single day, records a value that no LP can realise. A volume-weighted average over a stated window is the fairer construction and it is negotiable.
• A lock-up remaining on the shares at the distribution date makes the recorded value fictional by construction. Ask whether the shares are freely tradable and, if not, whether the valuation reflects a discount for the restriction.
• In-specie distributions also transfer a tax event to the LP on the fund's timetable rather than the LP's. For a taxable LP that is a real cost separate from the price risk.

Unfunded commitment

The amount an LP is still obliged to fund. It is the source of all liquidity risk in a private equity allocation, because it is a claim that can be exercised at any time, in an amount the LP does not control, most likely in the conditions in which the LP least wants to fund it.

Field	Value
Formula	Unfunded = C - cumulative calls + recallable distributions outstanding. Unfunded-years per unit of commitment = sum of the annual unfunded balances / C
Worked, the profile	76.14 percent of commitments unfunded at the end of year 1, 31.94 percent at year 3, 3.74 percent at year 5, and 0.22 percent at year 9
Unfunded-years	922.70 / 500.0 = 1.845400 unfunded-years per 1.00 of commitment
Peak single-year call	119.30, being 23.86 percent of commitments, in year 1
The correlation problem	Calls cluster in the early years and distributions in the later ones, so a programme in build-up is a net consumer of cash for years 1 to 4 and a net producer thereafter

• Unfunded commitment is not a liability on the balance sheet and it behaves exactly like one. The only sound way to hold it is against liquid assets that will still be liquid in the conditions that produce the call, which rules out holding it against the same equity market the fund invests in.
• The unfunded-years figure of 1.845400 is the constant that makes a pacing model work, and it is specific to the fund's call profile. A fund that calls faster has fewer unfunded-years and a smaller steady-state unfunded balance for the same commitment pace.
• A subscription facility reduces the frequency of calls and does not reduce the obligation. It shifts the same total drawing later and adds interest, which makes each individual call larger. The liquidity requirement does not improve.

Over-commitment

Committing more in aggregate than the cash available to fund it, relying on distributions from earlier vintages to fund later calls. It is not a strategy so much as an unavoidable consequence of holding a target NAV with a fund structure that returns capital.

Field	Value
Formula	Over-commitment ratio at steady state = (NAV + unfunded)/NAV = 1 + unfunded-years/NAV-years
Worked	1 + 1.845400/6.084000 = 1.3033x. A programme holding a 200.0 NAV carries 60.6640 of unfunded commitment at steady state
Independence of scale	The ratio is 1.3033x at every target size, because both terms scale with the commitment pace
What breaks it	Distributions stopping while calls continue. In year 4 the reference fund calls 90.50 and distributes nothing, so a programme relying on distributions to fund calls has a gap of 90.50 per vintage in that year

• The failure mode is not the ratio but the correlation. Every vintage in a programme calls capital in a bad market and distributes nothing in the same market, so the offsetting flows an over-commitment relies on disappear together. The reference fund's year-4 profile - 90.50 called, nothing distributed - is what that looks like for one vintage.
• The right stress test is straightforward and rarely run: assume distributions go to zero for eight consecutive quarters and calls continue at the modelled pace, then check whether the liquid reserve covers the gap. On a 200.0 NAV programme at a 32.8731 pace, two years of calls at the reference fund's profile is a substantial demand against no inflow.
• Over-commitment is often described as a way to raise exposure. It is more accurately a way to avoid a persistent shortfall in exposure, because a programme committing only what it holds in cash will hold a NAV well below its target for the whole build-up.

The pacing model in two constants

A commitment programme reaches a steady state in which the sum of live vintages' NAVs is constant. The pace needed to hold a target NAV is the target divided by the NAV-years a unit of commitment generates, and the resulting unfunded balance is the pace multiplied by unfunded-years.

Field	Value
Formula	Pace = target NAV / (sum of NAV_t / C). Steady-state unfunded = pace * (sum of unfunded_t / C). Both constants are properties of the fund's cash flow profile, not of its returns
The two constants	NAV-years per unit of commitment = 3042.0/500.0 = 6.084000. Unfunded-years = 922.70/500.0 = 1.845400
Worked, a 200.0 target	Pace = 200.0/6.084000 = 32.8731 per year. Steady-state unfunded = 32.8731 * 1.845400 = 60.6640. Total exposure 260.6640
Worked, the mature call profile	At a steady 32.8731 pace across ten live vintages, the annual call in a mature year is 32.8731 - the same as the pace, because every unit committed is eventually called
Time to steady state	Ten years, the fund's term. Before that the programme's NAV is below target by the NAV-years the missing vintages would have contributed

• The steady-state identity that the annual call equals the annual commitment pace is worth holding onto: it is true whenever total calls equal total commitments, which is the reference fund's case exactly. A fund that never fully calls its commitments, or that recycles, breaks it in opposite directions.
• Both constants come from the fund's cash flow profile and not from its performance, which is what makes the model usable before any returns are known. A slower-deploying fund produces fewer NAV-years per unit committed and therefore needs a higher pace for the same target.
• The most common pacing error is to model the target as a percentage of total portfolio assets and then not re-solve as those assets move. A falling public market raises the private allocation percentage without a single private cash flow occurring, and cutting the commitment pace in response is what produces the vintage-year gap that shows up eight years later.

Reading a distribution notice

A distribution notice states an amount, a source, a characterisation as return of capital or profit, and whether the amount is recallable. All four matter and only the first is always read.

Field	Value
Amount and date	Sets the LP's DPI and, through the date, its IRR
Source	A named realisation, a dividend or interest receipt from a portfolio company, or a borrowing. The third does not increase TVPI
Characterisation	Return of capital reduces unreturned capital and the pref base; profit does not. On the reference fund 500.0 of the 848.0 is return of capital
Recallable or not	Determines whether the LP's unfunded commitment has actually fallen

• Reconciling distributions to named realisations is the whole of the discipline. On the reference fund every distribution has a named investment behind it and the totals tie: 110.0, 30.0, 310.0, 225.0, 180.0 and 80.0 against investments A to F. Any distribution without a named source is worth a question.
• The characterisation drives the waterfall. Because return of capital reduces the pref base, a distribution characterised as capital rather than profit reduces the preferred return accruing thereafter, which is why the reference fund's pref stops accruing entirely after year 8.
• A recallable distribution has not reduced the LP's exposure at all, and it is the line most often omitted from an internal exposure report.