Fund Mechanicsside-letter

Side Letter

Also known as Side Letters, LP Side Letter, Side Agreement

Mikael Andersson
Mikael Andersson
VC Analyst · Updated

A side letter is a bilateral agreement between a fund and a specific LP that grants custom terms outside the main LPA. Common provisions include MFN rights, fee discounts, co-investment rights, ERISA carve-outs, and enhanced reporting. ILPA's 2019 Model LPA incorporates side letters into the main agreement and requires disclosure to all LPs.

In depth

A fund's LPA sets the rules every LP signs onto. A side letter is what the GP issues alongside that LPA to address one specific LP's needs. The most common drivers are regulation, tax, and economics: a public pension cannot accept investments in certain sectors, a sovereign wealth fund needs tax treaty representations, an anchor LP negotiated a fee break in exchange for committing early. Side letters carry the same legal weight as the LPA.

The risk to other LPs is information asymmetry. If a $200M anchor cut a 50 basis point management fee deal and no one else knows, the rest of the LP base is silently subsidizing that discount. The MFN clause exists to neutralize that risk, by giving non-anchor LPs the right to elect any side-letter term granted to comparably-sized investors.

ILPA's 2019 Model LPA standardized side-letter mechanics: incorporation by reference into the LPA, full disclosure to all LPs after final close, and automatic MFN extension subject to defined carve-outs. The model is not universal but it shifted market practice toward more transparency.

Why it matters

For LPs, the side letter is where actual investor protections get written. The LPA covers the legal skeleton. The side letter is where co-investment rights, transparency upgrades, and economic accommodations sit. Sophisticated LPs treat side-letter negotiation as the primary point of leverage in a fundraise.

For GPs, side letters are a fundraising tool and an operating burden. Anchor LPs expect material side-letter rights in exchange for committing early. Once issued, those rights become administrative obligations: MFN disclosure rounds, custom reporting templates, excused-investment tracking, and conflicts-of-interest management around co-invest allocation.

Worked example

A $300M Series A-focused fund closes with the following side letters:

LP typeCommitmentKey side-letter terms
Anchor pension$75M1.75% mgmt fee, 1.5x co-invest, quarterly ILPA reporting
Sovereign fund$50MTax-treaty reps, sovereign-immunity carve-outs, ERISA opinion
Family office (smaller)$10MMFN election rights, excused-investment in defense/tobacco
University endowment$25MMFN, UBTI blocker, public-records protection

The family office uses its MFN window to elect the pension's 1.75 percent fee. The endowment elects the same. The pension's anchor co-invest right is carved out of MFN because it was sized to commitment. Effective management fee for the fund drops from a blended 2.0 percent to roughly 1.85 percent once MFN elections complete, which the GP has to model when projecting gross-to-net returns.

Frequently asked

What's typically in a side letter?

MFN rights, management fee discounts for anchor commitments, co-investment access, ERISA or tax representations, excused-investment rights for restricted sectors, transparency upgrades like quarterly reporting in ILPA format, and notification rights. The exact mix depends on LP type and check size.

How does an MFN clause work in a side letter?

After final close, the GP discloses side-letter terms granted to LPs of equal or smaller commitment size. The MFN-electing LP then has a window, usually 30 to 60 days, to adopt any of those terms. Some MFNs are unlimited; 'schoolyard' MFNs only show terms from LPs at the same or smaller commitment tier.

How common are side letters in venture funds?

Near-universal at institutional scale. Per Ontra and industry surveys, MFN clauses appear in roughly 41 percent of side letters as of 2024, and side-letter volume per fund continues to grow. Small angel-style funds have fewer; large institutional funds may issue dozens.

Are side letters enforceable against later LPs?

Yes for the GP-LP relationship they govern. ILPA's Model LPA incorporates side letters into the main agreement so they bind the GP and the fund manager, and most institutional LPAs require the GP to disclose side-letter terms post-closing and extend more favorable rights to other LPs through MFN, with standard carve-outs for regulatory and structural accommodations.

What gets carved out of MFN coverage?

Terms granted for regulatory reasons (ERISA, tax treaty access), terms specific to an LP's legal form (sovereign immunity, public-records compliance), capacity rights tied to commitment size, and sometimes affiliate or employee terms. The carve-outs are negotiated and disclosed at the time of the MFN election.

Sources & further reading