‘Side letter’ is a term that gets used a lot but is not always explained. Simply put, a side letter is a separate agreement between a fund manager (the GP) and an individual investor (the LP) that sits alongside the limited partnership agreement (LPA). It adds, clarifies or amends specific terms for that particular investor.
Side letters were traditionally used by a small group of cornerstone investors committing large amounts of capital at an early stage. However, in today’s slower fundraising environment, where managers often take longer to reach a close, a much wider range of LPs have more scope to ask for tailored terms. Side letters have moved from being the preserve of a few anchor institutions to a standard part of many fundraisings.
The content of a side letter will depend on the investor’s needs and the fund’s strategy, but common themes include:
- Economics: Financial benefits including management fee discounts, carried interest arrangements or co-investment rights
- Regulatory and tax provisions: Clauses reflecting the LP’s jurisdiction, regulatory status or tax profile
- Policy alignment: Exclusions for certain sectors, enhanced ESG or DE&I reporting (primarily among European LPs), or specific ethical or jurisdictional constraints
- Operational terms: Tailored reporting, notice periods, excuse rights, liquidity features and transfer rights
For LPs, side letters are a way to make sure the fund aligns with their own mandates and internal policies, and to secure protections or benefits. For GPs, they can unlock commitments from investors who might otherwise be unwilling to invest.
There are, however, trade-offs. Side letters are legally binding agreements that must be tracked and honoured in day-to-day fund operations. Fees, carry, reporting, excusals and even liquidity provisions can differ between investors. As the number and complexity of side letters increase, so does the risk of misbilling, misallocation or simply overlooking an obligation.
Many funds also include “most-favoured nation” (MFN) provisions, which give certain investors the right to elect some of the terms granted to others. These can help maintain a sense of fairness, but they also multiply the number of provisions that must be monitored.
In short, side letters are now a core tool of modern fund structuring. They offer valuable flexibility for both LPs and GPs, but they also add operational and governance complexity that needs to be carefully managed.
For more in-depth guidance on side letters and the operational, compliance and regulatory considerations surrounding them, read our new side letters guide created in collaboration with Kirkland & Ellis LLP.
