Cash in, cash out

Cash flow management has always been a fluid blend of art and science. Recent currency movements have added a new layer of complexity for fund administrators. David Snow goes with the flow

It's a high-class problem, but it's still a problem – coordinating the transfer of cash between multiple limited partners, multiple funds and multiple portfolio companies. The good news is that your firm has so many committed supporters. The bad news is that success has created an administrative challenge that few deal-jockey founding partners are eager to address.

Among the many peculiarities of the private equity asset class is the idea of committed capital. A private equity ‘fund’ does not begin life with money in the bank, so to speak, but with the promise of money being made available when called for.

It is therefore a private equity firm's job to call capital from committed parties when necessary and distribute back profits when realised. A private equity investment typically begins with some form of communication from GP to LP that a certain amount of capital is required. Many American GPs know the satisfying sense of closure experienced when, often in a conference room filled with sellers and lawyers, they receive word that a federal reference number has been issued on a wire transfer, confirming that the transfer of funds is complete.

There is no standard approach to the task of cash management in the industry, and as many market participants can testify, the level of GP skill in this regard ranges from efficient and professional to sloppy and amateur.

Even the firms that have designed elaborate systems for efficient transfer of funds admit that a seemingly straightforward process can be daunting. “It would get a little messy sometimes, if we didn't have an organised approach and good systems,” says Brian Simmons, a founding partner of Chicago buyout firm Code Hennessy & Simmons (CHS). “We have four funds and different limited partner groups for each fund. And in each fund, the percentages are different. So there's a fair amount of math involved in doing a capital call or a distribution.”

Simmons describes the cash management task as ‘a mile wide and an inch deep.’ To ease the administrative burden of this process, CHS has built its own automated system for sending out capital call and distribution notices. The firm's proprietary database automatically generates LP communiqués with the appropriate dollar figures for each transaction.

Cash management is not a purely administrative consideration. The execution of capital calls and distributions affects performance. This fact is foremost on the mind of Evelyn Pellicone, chief financial officer in the New York office of global private equity firm Apax Partners. Pellicone's duties include making sure that the flow of cash from LPs to portfolio companies and back is designed to maximise the internal rate of return.

Once capital is called, the IRR clock begins to tick, and money not put to work suffers from opportunity cost. “We need to keep a low balance of cash at all times,” says Pellicone. “Idle cash is detrimental to the performance of the fund.”

Pellicone notes that most partnership agreements set forth rules on the cash balance that funds are allowed to maintain.

David Emmerich, a vice president of professionals banking at Citizens Bank, who specialises in bank accounts for private equity partnerships, says idle cash is enough of a concern that his clients will sometimes utilise overnight ‘sweep’ services that place cash in special money-market accounts.

Under the principle of ‘just-intime’ investing, Apax and many other private equity firms give their limited partners ten business days prior notice on capital calls. Capital calls related to the financing of existing portfolio companies (‘working capital’ or follow-on investments) are easier to time. But just-in-time becomes more complicated on new deals.

As any deal professional can attest, negotiations and due diligence can go any number of directions prior to the close of a transaction. This requires Pellicone and other financial professionals at private equity firms to be as keenly apprised of the progress of negotiations as anyone else in the firm. In the interest of smooth timing, sometimes capital calls are made even before investments receive final approval. “You really have to pay close attention to your pipeline and figure out when you need that cash,” Pellicone says.

While most limited partners are given ten-day advanced notice, many want an additional heads up. CHS' Simmons notes that limited partners don't want to get hit with capital calls and distributions without prior warning and a respectable level of explanation. Increasingly, investors want to know in advance how their money is going to be used, not just how much of it is needed.

“We frequently send out a notice ahead of time alerting LPs to an upcoming distribution” Simmons says. “On distributions, for example, we'll let our LPs know how cash being distributed breaks down between profits and return of basis.”

Further complicating the timing issue is a concern that might be termed ‘bugging your LPs too much.’ Private equity funds with multiple portfolio companies will have innumerable reasons to call capital – new investments, add-ons, working capital, second rounds, etc. “Ideally, you don't want to be making calls to limited partners every other day,” notes Apax's Pellicone.

Working with her own team and deal professionals, constructs forward-looking models on when likely financings will occur so that Apax can bundle multiple capital calls into single communications.


Total capital calls Total distributions
America's largest Feb-03 $152,468,137.47 $51,797,131.72
pension sees a private Mar-03 $139,837,086.23 $48,080,179.00
equity capital inflow Apr-03 $134,991,483.48 $47,783,444.00
and outflow that dwarfs May-03 n/a n/a
most other programmes. Jun-03 $149,943,230.31 $112,367,647.50
A recent sampling of Jul-03 $171,040,316.95 $103,586,154.00
capital calls and distri- Aug-03 $78,342,758.52 $175,808,926.61
butions at the California Sep-03 $164,057,042.10 $99,091,985.52
Public Employees' Oct-03 $210,513,126.12 $133,914,290.85
Retirement System: Nov-03 n/a n/a
Dec-03 $228,584,948.46 $167,501,554.41
Jan-04 $162,978,486.22 $245,404,056.01
Source: CalPERS