Equalisation in the capital call context

Equalisation is a mechanism used in private funds to ensure that investors who join the fund at different closing dates contribute capital and receive returns as if they had invested from the fund's first close, preventing earlier investors from being advantaged at the expense of later investors (or vice versa) because of the timing of their entry.

In a capital call context, equalisation specifically addresses the difference in called capital and accrued management fees between LPs who committed at the first close and LPs who commit at a subsequent close.

How it works

When a private fund holds multiple closings, early-close LPs and late-close LPs face different economic positions. An LP who committed at the first close has had capital called and at-risk earlier, and has paid more management fee, than an LP who joins at the third close six months later. Without equalisation, the late-close LP benefits from the same investment exposure as the early-close LP but has had less capital at risk and paid fewer fees.

Equalisation corrects this by requiring late-close LPs to make an equalisation payment that effectively puts them in the same position as if they had committed at the first close. This payment has two components:

The first is a capital equilisation contribution. Late-close LPs pay a proportion of the capital already called from earlier closers, so that all LPs have the same called-to-committed ratio from the late-close date forward.

The second is an interest charge (sometimes called a "catch-up" on fees and returns). Late-close LPs typically pay interest on the equalisation capital, calculated at a rate specified in the LPA (commonly the hurdle rate or a defined reference rate), covering the period from the first close to the late-close date. This interest compensates earlier LPs for the opportunity cost of having had their capital at risk while the late-close LP did not.

The equalisation payment flows from the late-close LP to the fund and is then redistributed to the earlier-close LPs (either directly or by reducing their future capital calls).

Some funds handle equalisation differently. In an "escrow" or "hold-back" approach, a portion of each early-close LP's called capital is held in escrow and returned when a late-close LP joins, funded by the late-close LP's equalisation payment. In a "bridging" approach, the general partner or the subscription facility funds the difference until the late close, and the late-close LP's equalisation payment repays the bridge.

For fund administrators, equalisation creates complex capital account mechanics. The administrator must calculate: the total amount called from each earlier closing; the interest due from each later-close LP on their equalisation capital; the redistribution of equalisation proceeds to earlier-close LPs; and the updated capital account position for each LP after equalisation is processed. These calculations must be documented and, for larger fund closings, verified by the fund's auditors.

The equalisation provisions in the LPA govern the mechanics. Administrators must read these provisions carefully before processing any late closing, as the approach (whether it uses interest, escrow, or a different mechanism) varies significantly between fund managers.

Worked example

Ashford Private Equity Fund V holds a first close in March with EUR 200 million in commitments from eight LPs (the "First Closers"). It makes three investments using capital called from the First Closers, totalling EUR 40 million in capital calls.

In September, the fund holds a second close with two additional LPs (the "Second Closers") committing EUR 100 million (bringing the total fund to EUR 300 million).

Equalisation at the second close:

Capital called to date (as % of First Closer commitments): 20% (EUR 40M / EUR 200M)

Capital equalisation amount from Second Closers: 20% of EUR 100M = EUR 20M

Interest on equalisation capital (assuming 8% hurdle rate, 6-month period from March to September): EUR 20M x 8% x 6/12 = EUR 800,000

Total equalisation payment from Second Closers: EUR 20,800,000

This amount is received from the Second Closers and redistributed to the First Closers in proportion to their commitments. The First Closers receive the EUR 800,000 interest as compensation for having had their capital deployed for six months before the Second Closers joined.

Going forward, all LPs have the same called-to-committed ratio (20% of commitment), and future capital calls are issued to all LPs on the same pro-rata basis.

Frequently asked questions

What is the difference between equalisation and a catch-up provision? Equalisation and GP catch-up are different mechanisms. Equalisation addresses the timing difference between LP closing dates: it ensures all LPs, regardless of when they joined the fund, are economically treated as if they invested at the first close. GP catch-up is a distribution waterfall mechanism by which the GP receives 100% of distributions above the LP preferred return (until the GP has caught up to its full carried interest percentage) before reverting to a standard split. Both mechanisms use the term "catch-up" colloquially, but they serve different purposes.

What happens if a late-close LP cannot pay the equalisation amount? Failure to pay an equalisation amount is treated similarly to a capital call default under the LPA. The consequences may include exclusion from the fund, forfeiture of a portion of the commitment, or interest on the overdue amount. In practice, equalisation payments are negotiated with late-close LPs before the close is finalised, so the amount is known in advance. An LP who cannot meet the equalisation payment would typically not complete the closing.

How is the equalisation interest rate determined? The LPA specifies the rate, which commonly references the fund's preferred return rate (hurdle rate), an agreed fixed rate, or a market reference rate. The choice of rate affects the economics of late closing significantly: a higher equalisation interest rate makes later closing more expensive for the late-close LP and more beneficial for the First Closers.

Is equalisation required under AIFMD? No. Equalisation is a commercial arrangement defined in the fund's LPA; it is not prescribed by AIFMD or any other EU fund regulation. However, AIFMD's investor disclosure requirements (Article 23) require that the capital call mechanism and any equalisation provisions be described in the fund's offering document, so that prospective late-close investors understand the economics of joining at a subsequent closing.

Can equalisation be waived for a particular LP? Yes, through a side letter. Some large or anchor LPs negotiate equalisation waivers or modified equalisation terms as part of their commitment negotiation. These waivers are disclosed to the LPAC under the fund's "most favoured nation" provisions, if applicable. Other LPs may have the right to request equivalent treatment if a waiver is granted to one LP.

Related terms

Capital call, Distribution waterfall, Preferred return, Subscription line / capital call facility, Recall / recallable distribution, LPA

Related pages

How equalisation works in private fund closings, Swelv for fund administrators