Equalization: Making Late LPs Pay for Time

A fund that closes twice has to rewrite history. Investors who arrive at a second close must end up exactly where they would have been on day one. Equalization is how the fund gets them there, and it costs them cash.

Why it matters: On the same capital call, the two late investors below wire 33.33% of their commitment while everyone else wires 12.33%. They also pay interest for the 181 days their money sat unlocked.

The setup:

First close, 2/28/23: $200,000,000 committed across 1 GP and 5 LPs.
Capital call #1: $42,000,000, or 21% of every commitment. $158,000,000 stays uncalled.

Investor	Commitment	Ownership	Call #1	Uncalled
GP	5,000,000	2.50%	1,050,000	3,950,000
LP1	90,000,000	45.00%	18,900,000	71,100,000
LP2	5,000,000	2.50%	1,050,000	3,950,000
LP3	30,000,000	15.00%	6,300,000	23,700,000
LP4	40,000,000	20.00%	8,400,000	31,600,000
LP5	30,000,000	15.00%	6,300,000	23,700,000
Total	200,000,000	100.00%	42,000,000	158,000,000

Then the fund closes again. The LPA keeps the closing window open, so on 8/28/23 two new investors commit $25,000,000. Committed capital rises to $225,000,000.

Everyone already in is diluted. LP1 falls from 45.00% to 40.00%.
The new investors have funded nothing. Their capital was free to earn elsewhere while the first close's money sat locked in the fund.

The question the LPA has to answer: what do the latecomers owe for that head start?

Step 1: Restate the first call. Call #1 does not change size, it changes percentage. $42,000,000 against $225,000,000 is 18.6667% of every commitment, not 21%.

Each investor's catch-up is the gap between that restated share and what they have already funded.

\text{Catch-up}_i = C_i \times \frac{42{,}000{,}000}{225{,}000{,}000} - \text{Funded}_i

Positive means the investor owes the fund. Negative means the fund owes the investor.

Step 2: Price the delay. The catch-up carries interest from the first close to the second, 181 days on a 360-day convention, at a floating benchmark of 4.00%.

\text{Equalization interest}_i = \text{Catch-up}_i \times 4.00\% \times \frac{181}{360}

New LPs pay it. Existing LPs receive it.
The GP is treated like any other investor here, on its own 5,000,000 commitment.

Investor	New ownership	Change	Catch-up	Interest
GP	2.22%	-0.28%	(116,667)	2,346
LP1	40.00%	-5.00%	(2,100,000)	42,233
LP2	2.22%	-0.28%	(116,667)	2,346
LP3	13.33%	-1.67%	(700,000)	14,078
LP4	17.78%	-2.22%	(933,333)	18,770
LP5	13.33%	-1.67%	(700,000)	14,078
LP6 (new)	2.22%	+2.22%	933,333	(18,770)
LP7 (new)	8.89%	+8.89%	3,733,333	(75,081)
Total	100.00%	0.00%	0	0

Step 3: Net it into the next call. Capital call #2 is $33,000,000, or 14.6667% of commitments. The catch-up rides along in the same call letter rather than moving as a separate wire.

Investor	Call #2 pro rata	Catch-up	Wired	Call #2 %
GP	733,333	(116,667)	616,667	12.33%
LP1	13,200,000	(2,100,000)	11,100,000	12.33%
LP2	733,333	(116,667)	616,667	12.33%
LP3	4,400,000	(700,000)	3,700,000	12.33%
LP4	5,866,667	(933,333)	4,933,333	12.33%
LP5	4,400,000	(700,000)	3,700,000	12.33%
LP6 (new)	733,333	933,333	1,666,667	33.33%
LP7 (new)	2,933,333	3,733,333	6,666,667	33.33%
Total	33,000,000	0	33,000,000	n/a

Between the lines: the fund never holds the equalization interest. It collects the amount with the call and pays it straight out to the existing LPs, which is why the interest column sums to zero.

The bottom line: every investor now sits at 33.33% called, with $192,000,000 uncalled, or 66.67% of the fund. Capital was equalized by arithmetic. Time was equalized by interest.

Go deeper

The full model, capital account and interest schedule included, is in the attached workbook. It is the same methodology I built for a VC fund client, so you can run an equalization for your own fund with it.

First Principles Finance

Equalization: Making Late LPs Pay for Time

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