A side letter is a bilateral agreement between a general partner and a specific limited partner that modifies or supplements the terms of the fund's limited partnership agreement for that LP only. Side letters allow the GP to accommodate the particular legal, regulatory, or commercial requirements of significant LPs without amending the LPA for all fund participants.
How it works
Side letters are negotiated during the fundraising period, typically in parallel with the LP's subscription process. They are binding on the GP (and the fund, to the extent the GP has authority to bind the fund) and are confidential between the parties, though the LPA typically requires the GP to disclose to all LPs that side letters exist, even if their content is not shared.
The range of terms addressed in side letters is broad. Common categories include: fee modifications (management fee reductions or rebates for large anchor investors); most-favoured-nation (MFN) clauses (which require the GP to offer the LP terms at least as favourable as those offered to any other LP in the same fund); co-investment rights (the right to participate alongside the fund in investments above a specified size); enhanced reporting rights (more frequent or more detailed NAV statements, additional portfolio company information); transfer restrictions (limited partners with sovereign or government-related status may require specific transfer restriction provisions); regulatory accommodations (provisions addressing ERISA plan asset rules, UBTI restrictions for US tax-exempt investors, or specific AIFMD or FATCA disclosure requirements); and redemption or liquidity provisions (unusual in closed-end funds but sometimes included for specific LP types).
MFN clauses deserve particular attention because they create operational complexity for fund administrators. An LP with a broad MFN clause is entitled to elect the benefit of any more favourable term granted to any other LP in the same fund. If the GP grants LP Alpha a 10% management fee reduction and LP Beta has an MFN clause covering fee terms, LP Beta may be entitled to elect the same reduction. The administrator must track MFN elections, determine which terms are covered by each MFN clause, and adjust fee calculations accordingly.
Side letters are reviewed by the fund's counsel at each closing to ensure they do not conflict with the LPA and do not create obligations the GP cannot legally or practically fulfil. Administrators receive copies of side letters (or relevant extracts) to implement the operational provisions; the GP typically provides side letter extracts covering reporting, fee, and payment-related terms to the administrator rather than the full document.
Worked example
Greenfield Capital Fund IV (EUR 600M) grants side letters to three LPs:
LP Institutional Holdings (EUR 120M commitment, largest single LP): management fee reduced to 1.5% during the investment period (vs. standard 1.75%); MFN clause covering fee terms; enhanced quarterly reporting including individual portfolio company valuations; co-investment right on any deal over EUR 75M.
LP Nordic Pension (EUR 80M commitment, government pension fund): ERISA plan asset safe harbour representation from GP; no transfer without consent to any entity on the Nordic government's restricted party list; annual confirmation of AML status of underlying investments.
LP Sovereign Wealth (EUR 100M commitment): additional transparency reporting in a format compatible with its internal governance requirements; GP representation that no portfolio company revenues derive from activities inconsistent with Sovereign Wealth's ESG policy.
The fund administrator receives extracts from each side letter covering the fee modification for LP Institutional Holdings and the enhanced reporting requirements for all three LPs. The administrator adjusts the management fee calculation for LP Institutional Holdings, adds enhanced reporting schedules for the three LPs, and notes the ERISA representation obligation in LP Nordic Pension's compliance file. The MFN clause for LP Institutional Holdings is flagged to the GP: if any subsequent LP receives a fee below 1.5%, LP Institutional Holdings may elect that lower fee.
Frequently asked questions
What is a most-favoured-nation clause in a side letter? An MFN clause requires the GP to offer the LP any more favourable term granted to another LP in the same fund during the same fundraising. The clause typically specifies the categories of terms it covers (fees, reporting, co-investment rights), the notice period for election, and how the LP exercises the right. Broad MFN clauses covering all terms are LP-friendly; GPs prefer narrowly scoped MFN clauses limited to specific categories.
Are side letters disclosed to other LPs? The existence of side letters is typically disclosed (the LP subscription agreement includes a representation that side letters exist). The content of individual side letters is confidential between the GP and that LP. However, MFN clauses create indirect disclosure: an LP exercising an MFN right knows that another LP received a more favourable term, even if it does not know which LP or the full details of that LP's side letter.
Can a side letter be enforced against a new fund administrator? Side letters are binding on the GP and the fund. If a fund changes administrator, the incoming administrator is required to implement the provisions of existing side letters that fall within the administrator's operational scope (fee adjustments, reporting requirements, payment terms). The outgoing administrator should transfer side letter extracts as part of the transition. Failure to implement side letter provisions creates legal and reputational risk for the GP.
What happens if a side letter term conflicts with the LPA? Generally, the LPA governs and side letter terms that conflict with it are invalid. However, some LPAs include specific provisions authorising the GP to grant side letter terms that would otherwise modify LPA provisions (such as fee reductions), up to specified limits. Where a conflict exists and is not addressed by these provisions, the GP faces potential breach of fiduciary duty to non-side-letter LPs if the side letter term advantages one LP at the expense of others.
Related terms
LPA, Subscription agreement, Management fee, Capital account, Transfer agency, AIFMD and capital calls
Related pages
Side letter management in private fund administration, Swelv for fund administrators