Side Letters: What Large Investors Negotiate Privately

The main documents in a funding round or a venture fund set out terms that apply to everyone. But large or strategic investors often negotiate additional rights in a separate agreement: a side letter. These private arrangements can be routine and harmless, or they can quietly give one investor advantages others do not know about.

Side letters appear in two settings: between limited partners and fund managers, and between investors and the startups they back. This guide explains what each typically contains, why they matter, and what founders, fund managers and other investors should watch for.

1. Side Letters in Venture Funds

When a fund raises capital, larger or strategic LPs often negotiate side letters with the general partner. Common terms include:

• Fee discounts on management fees or carried interest for large commitments.
• Most favoured nation (MFN) rights, giving the LP the benefit of better terms granted to other LPs of similar size.
• Co-investment rights, offering the LP opportunities to invest directly alongside the fund, often with low or no fees.
• Enhanced reporting, such as more detailed or more frequent information.
• Excuse rights, allowing the LP to opt out of investments that conflict with its policies, for example certain sectors or jurisdictions.
• Advisory committee seats, giving the LP a formal role in governance.
• Regulatory and tax provisions required by the LP's own rules, such as for public pensions or sovereign funds.

The US Securities and Exchange Commission adopted rules in 2023 to limit certain preferential treatment and require disclosure in private funds, but a federal appeals court vacated those rules in 2024. Disclosure of side letter terms to other LPs therefore depends largely on fund documents and negotiation. See our guide to becoming an LP.

2. Side Letters in Startup Rounds

In startup financings, side letters usually give specific investors rights beyond the standard documents:

• Information rights above the standard level. See information rights.
• Pro rata rights for investors who fall below the "major investor" threshold. See pro rata rights.
• Board observer seats.
• Management rights letters, which some funds need for regulatory reasons, giving them the right to consult with management.
• Strategic rights for corporate investors, such as notice before the company talks to acquirers, or commercial terms.
• Regulatory provisions, for example limits on information or control rights to avoid foreign investment review.

3. Why Side Letters Matter

• Hidden advantages. Other investors may not know that one investor has preferential economics or access.
• Future complications. Rights granted to one early investor can conflict with what later investors demand.
• Signalling risk. Strategic rights such as rights of first refusal on acquisitions can deter other buyers.
• Administrative burden. Many bespoke obligations are hard to track and comply with.

4. What Founders Should Watch For

• Keep a register of every side letter and its obligations.
• Avoid rights that constrain an exit, such as rights of first refusal or first negotiation on an acquisition.
• Limit information rights for investors who might compete or who are connected to competitors.
• Add sunset clauses so rights end at a future financing or after a set period.
• Take legal advice on whether side letters must be disclosed to other investors.

5. What LPs and Investors Should Ask

1. Are there side letters with other investors, and which terms do they include?
2. Do I have MFN rights, and how are they defined?
3. Are any side letter terms likely to affect my economics or rights?
4. For startups: has any investor received strategic rights that could affect an exit?

Frequently Asked Questions

Are side letters legal?

Yes. They are common and legitimate, but they must be consistent with the main documents and applicable law.

Do other investors see side letters?

Not always. Disclosure depends on the fund or company documents, any MFN rights and negotiation.

What is an MFN clause?

A most favoured nation clause lets an investor receive the benefit of better terms offered to comparable investors.

Should founders refuse side letters?

Not necessarily. Many are reasonable. Founders should avoid terms that restrict future financing or exits, and track all obligations carefully.

The Bottom Line

Side letters let large and strategic investors meet their specific needs without rewriting the main documents. Most are routine, but some grant significant private advantages. Founders, fund managers and co-investors who track, limit and understand them avoid surprises at the next round or at exit.

Global Capital Network connects founders, fund managers and investors through our events and investor network. Get in touch to learn more.

This article is general information, not legal advice.