The “capital calls” crisis: separating fact from fiction

Recently, reports started circulating that Ambric, a chip company that enables high-performance computing, has shuttered after failing to raise money from its investors.

Ambric’s fate was sealed by a “capital calls” problem, according to a report in EETimes, a story that was then picked up by GigaOM and even the New York Times. As told, the tale is a tragic one: Ambric had completed production of its products, was getting orders, and was just beginning to earn revenue. That is, before it became an innocent victim of the capital crunch.

Here’s how “capital calls” work. Occasionally, as they make investments, venture capitalists call in money from their own investors, known as limited partners. These LPs usually have the money stowed away in some form of liquid cash. But during the crunch, they simply didn’t have enough on hand to uphold their commitments. So, as the story goes, Ambric’s VC investors turned their backs on the company, and it was forced to close.

After we asked around, however, it turns out this explanation is simply not true. Yes, capital calls have become a problem, as we’ve reported (as have others). But in Ambric’s case, the issue was just used as an excuse by the company for its demise even though it apparently wasn’t a contributing factor, according to several sources, including Ambric representatives.

Here’s what really happened: Ambric knew it needed to raise more money this year, says Joe Herbst, its former vice president of marketing. It had successfully cleared the first hurdles for selling its products, but had a ways to go before full-scale production. Unfortunately, its early backers, OVP Venture Partners, Northwest Technology Partners and ComVentures, felt they’d already invested all they could. In consultation with Ambric, they realized the company needed to raise between $20 and $30 million more in order to prove its model, we’re told. So they encouraged management to sell out to a big-pocketed buyer.

At that point, Ambric approached a firm called Advanced Equities Inc., which signed a private placement memorandum stating that AEI would try to raise $20 million for the company. When the firm failed to muster more than $7 million in commitments, Ambric backtracked to raise a round directly for itself, but couldn’t.

Headquartered in Chicago with global offices, AEI doesn’t have a typical LP structure. It contracts to raise money for companies like Ambric — but it didn’t make any legal commitment to raise the full $20 million. There were no capital calls, missed or otherwise. AEI declined to comment on the situation. Ambric’s Herbst, however, doesn’t dispute any of this.

He says Ambric is merely pointing out that the company’s hardships came at the same time as the mortgage industry crisis, led in part by the collapse of insurance giant AIG. This event, in turn, sparked a series of crises at other large investors, resulting in the widespread capital call problem we’ve discussed.

Some LPs sought to sell their ownership stakes in VC firms on the “secondary market,” sometimes for 50 cents on the dollar. These LPs warned their venture firms that they shouldn’t make capital calls, because if they did, they may not be able to pay up. True, this may have affected many startups by stalling funds promised to them by VCs. But this wasn’t the case with Ambric.

Reports are beginning to leak out about large institutions defaulting on their commitments to VC firms. Washington Mutual, for example, failed to make good on part of a $10 million commitment to venture firm FTVentures (something that was easy to spot down the road). It also failed to make a capital call worth $700,000 to Financial Technology Ventures Fund III, and another worth $30,000 to Arch Venture Fund, according to the WSJ. But what we’re hearing now is that, in the vast majority of cases, LPs are scrambling to sell their ownership stakes in VC firms in order to essentially dodge their capital calls. Those sales are largely taking place in the background, and have led to relatively few cases of VC firms defaulting on commitments to startups.