What is a Non-Mandatory Capital Provision?

What is a Non-Mandatory Capital Provision?

Optional Call for Funds: Unlike mandatory capital calls which obligate investors to provide additional funds when called upon, non-mandatory provisions give the company the option to request additional capital but do not force investors to comply.
Flexibility in Fundraising: This type of provision offers flexibility, allowing the company to seek additional funds if needed, but without binding the investors to contribute.
Voluntary Participation: Investors can decide whether to participate in the capital call based on their financial situation, interest in the specific investment opportunity, or their assessment of the company's performance.

Why are Non-Mandatory Capital Provisions Included in Company Agreements?

1. Investor Attractiveness: These provisions can make the investment more attractive to some investors who may be hesitant to commit to mandatory capital obligations.
2. Risk Management for Investors: They provide a layer of risk management for investors, allowing them to choose whether to invest more based on the company's performance and market conditions.
3. Adaptability to Market Conditions: This provision enables both the company and its investors to adapt to changing market conditions, making decisions on additional funding based on the current economic environment.
4. Support for Long-Term Projects: For projects that have long-term horizons, such as real estate, these provisions allow companies to raise additional funds in stages as the project progresses and needs evolve.
5. Adapting to Market Conditions: Non-mandatory capital calls allow LLCs to respond to market opportunities or challenges as they arise, giving members the choice to participate or not.
6. Operational Needs: LLCs, especially those involved in ventures like real estate or startups, may have fluctuating capital requirements. Non-mandatory capital calls provide a way to meet these needs without the strict financial obligation that mandatory calls impose.
7. Flexibility in Financing: LLCs benefit from the flexibility that non-mandatory capital calls provide. They can request additional funds from members as needed, but without obligating them to contribute. This flexibility is particularly useful for LLCs that may encounter varying financial needs over time.

Assumptions when doing a Capital Call?

1. Lack of Knowledge: Do not assume that your members/investors understand what a capital call is.

2. Shock: Every investor (Accredited and Sophisticated) should read their investment legal documents prior to signing and funding their investment. Note: most investors neither read nor have an attorney and/or CPA review their documents prior to signing. Did you know that 75% of every Private Placement Memorandum has disclosures as to the riskiness of the type of investment they are investing in?

3. Amnesia: Never assume that any investor remembers the risks associated with the potential rewards of their investments. If they do remember, they have suddenly forgotten that. Keep in mind that for most inexperienced investors, a capital call can be a scary subject. They are not used to being members/partners in a company that have provisions allowing the company to call capital if/when the need arises.

4. Empathy: Try to be empathetic and transparent when talking to investors about capital calls. Even with a capital call, there are NO guarantees as to how your investment will turn out. There are many reasons why companies need capital (some external and some internal).  Be understanding of your investors’ concerns when discussing capital calls with them. Again, most investors have never been subjected to them, unless they are part of a blind fund or evergreen fund that constantly calling capital.

Choices!

With a non-mandatory capital call, you have the choice to contribute or not to contribute. There are pros and cons; as to either decision. Choosing to contribute on a capital call will most likely prevent you from by diluted with non-contributing members. Many times, incentives are offered to those that contribute; and, you are helping to ensure that the company does not have to go outside its investors to seek additional funds needed. The cons included, but are not limited to: (i) dilution for non-contributors; (ii) putting good money after bad money; (iii) potentially needing another capital call in the future; and (iv) terrifying investors who are not versed in capital calls, nor why they were in their agreement in the first place.

For more information on capital calls and/or alternatives to capital calls, reach out to us at info@kaliserlaw.com.