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Comment by thdxr | Hacker News Reader

while I agree with the general premise (majority of VCs are not good investors) it's important to remember the money they raised isn't sitting in a bank account.

It's likely still in the LPs stock portfolio, doing a capital call when everyone is down a lot can be tricky. You need to sell the investment more even though they agreed to give you the money when you asked

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Fwiw - my general premise isn't that the "majority of VCs are not good investors." My point is that there's a serious disconnect in the markets right now, and that it is rooted more in fear than a lack of opportunity.

On the second point - you're right that the cash isn't literally sitting around, but VCs (generally) do not have to ask LPs for approval on a deal by deal basis. Capital calls can happen either as tranches or in response to a deal, and it is unusual for an LP to successfully refuse a capital call because of a specific deal.

If you just view VCs as any other business, it involves revenue (exits) and costs (investments). The market turmoil is affecting the volume and size of exits in at least the short term, which means they are cutting costs. It's not clear the number of opportunities have grown/shrank but i guess fewer people trying to invest means the number of available opportunities to you as a player has grown.

Yeah I was super confused by this. VCs generally don’t have all the money ready to invest. They may have raised a $300 mil fund but they don’t get that money until they call it in. If the LP says “no deals for 6 months” that’s how it is.

What if the LP says no deals for 50 years? These “fund raised X” means nothing if they can’t enforce capital calls

That should be actionable as a breach of contract, with a notable exception of sovereign wealth funds, which may or may have immunity: https://www.reedsmith.com/en/perspectives/2013/11/capital-ca...

If the LPs don’t meet the capital calls, they’re in breach of their investor agreement, and the penalties are generally quite harsh, including potentially forfeiting a lot of the value they currently have in the fund.

Exactly. You either have the capital ready to roll or you should not engage in any such commitment.

As an LP in a large fund: that's definitely not how it is.

As an LP you pre-commit to a certain level, and when the capital call comes you perform or you will be found to be in default when a whole pile of clauses kicks in that you really do not want to have to deal with. You will have to have an extremely good reason (such as being already bankrupt) to be able to avoid a capital call that you have committed to.

There are LPs and LPs.

The LPs which the user above refers to are the APGs, the PFZWs type.

Show me a contract where an LP gets to renege penalty free on their obligations to a VC and I'll be happy to believe you.

I have been part of 222 VC/PE deals to date (that's not a typo, just a coincidence) and not once has an LP reneged on their obligation to honor a capital call without penalty. That's not saying it doesn't happen, it may well happen, or it may have happened and it was kept so quiet that nobody picked up on it (which is somewhat believable, because it would reflect very badly on the fund).

Just to give you one example: a VC enters into a deal, signs a non-binding terms sheet conditional on doing DD, goes through a full DD and then has to back out of the deal because a large LP does not honor their commitment. The fall out from that would be massive.

What is far more likely to happen is that a VC can't find a good way to spend the funds committed capital. In that case there might be extensions of the funds run or they might end up simply not calling up the available capital. This I've seen a couple of times. But an LP that refuses a capital call I've yet to see. I've even seen an estate that was held to perform when an LP ended up with the very best reason for non-performance of all.

I understand all the above, but the general rules kinda supercede it all.The general rules are that when you are the best/biggest thing around the block, rules just don't apply to you.

Also in general when government is involved rules don't apply to it. 80% or more of the amount of money that LPs as a whole administer are either Govt. Pension Funds or SWFs.

So in the case of big LPs it's one of the rare cases where both the above rules are at play to give them carte blanche.

LPs in a fund usually - possibly not always - have the same conditions except for the 'anchor' LPs, who are declared up front to the other LPs and who put in a substantially larger chunk of cash and commit before the fund is even officially opened. They are committed to do so and are listed in the rest of the documentation by name. Even the anchor LP agreements that I've seen do not allow those to default on their commitment, though there may be priority assignment in case of returns.

Again, show me. Just. One. Contract. I'll be happy to read the whole thing even if it is 200 pages.

Oh and just to be clear about this: if smaller LPs were on the hook for the full amount but larger LPs could walk at will how big do you think the chances are that those smaller LPs would still want to be part of such a fund?

Because clearly if a large contributor has a reason to back out they may have an even better reason to do the same.

Personally I would not invest in a fund where a larger LP can back out at will.

You are confused because you think the contracts mean anything in such a world. The contracts are worth less than the paper they are printed on when push comes to shove and you are facing a whale.

We're talking about whales facing whales, think Elon Musk vs Twitter and believe me contracts mean everything in that world.

There isn't an alternate reality where contracts are meaningless.

> Just to give you one example: a VC enters into a deal, signs a non-binding terms sheet conditional on doing DD, goes through a full DD and then has to back out of the deal because a large LP does not honor their commitment. The fall out from that would be massive.

Is this in Europe?

You are viewing the problem wrong. If you don't want to pay and you are a big fish, you just tell them not to ask. VC world is based on reputation and politeness. Causing a big stink is not a good look for anyone. If you are a big LP and you say, look buddy, we are taking this quarter off, what do you think is going to happen?

What would happen is a revolt of the other 200+ LPs who all collectively represent a much larger fraction of the fund than any one whale because they will have to cover for the shortfall; not to mention other whales who may see things differently.

On every capital call there is a statement that lists the total amount and the pro-rata and if the ratio there would suddenly change that would be a breach of contract. As an LP you know up front how big a chunk of the total fund your commitment will be with possible upside if the fund is oversubscribed and if it is undersubscribed it either won't launch of you will be made aware of the change and given the option to walk away.

To see the fund effectively shrink post launch and the shortfall pushed onto the smaller LPs is ridiculous, especially if LPs were not previously told that this could be the case.

This is understandable, but wouldn’t it also happen that the LP uses various signals to communicate to the VC that now’s a bad time?

Such as opening the small talk a Zoom call by saying ‘it’s been a very difficult month for us.’

There are very few VCs who won’t be influenced by a signal even as simple as this one.

That could happen, but it would affect all LPs equally. If proof of such a call ever leaked the fund would be open to lawsuits from a whole pack of hyenas (high net worth individuals for whom the LP commitment is roughly equal to a scratch lottery ticket to an ordinary citizen) and who collectively represent the larger part of the funds' total commitment.

The people running these funds are not idiots and would not willingly put themselves into a position like that.

Also, if credibly alleged there won't be a next installment of that particular fund.

No, that's not how it is. If the LP doesn't pay their capital call they go into default and the returns on all the money they've invested so far can be taken away. The only LPs who default on the capital call are individual investors who are flat out broke. They will of course default on their capital call before their mortgage.

What if there are no returns on all the money they have invested so far? This is quite possible in a bubble followed by a downturn.

Then you refer to your contract where on page 1 it states fairly clearly that there are no guarantees of returns and that the management fee is on the amount 'under management', and that a capital call will be inbound.

Obviously all of these scenarios tend to be covered by the contracts and if you can't read a contract of that level of complexity then you should not be playing this game.

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