A side letter is a separate agreement between an SPV or fund manager and one investor that changes or adds to the terms in the main operating agreement, without amending that document for everyone else. Sponsors use them to accommodate a specific investor’s requirements, most often a large check, an institutional investor with its own compliance rules, or an early backer the manager wants to keep close, while leaving the standard terms untouched for everyone else.
This guide covers what typically goes into a private equity side letter, how it interacts with the SPV’s main documents, and what both sides should watch for before signing one.
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What a side letter is
A side letter is a contract, usually just a few pages, that sits alongside the subscription agreement and operating agreement an investor signs. It does not replace those documents; it modifies or supplements specific provisions for that one investor only. Because it binds only the manager and the investor who signed it, other investors in the same SPV are not bound by its terms and, absent a most favored nation clause, are not entitled to the same treatment.
Common terms found in side letters
Most favored nation clauses
A most favored nation clause, often shortened to MFN, gives an investor the right to be notified of more favorable terms the manager grants to another investor in the same vehicle, and to elect some or all of those terms for itself. Institutional investors frequently ask for an MFN clause as a condition of investing, since it protects against a smaller or later investor negotiating better economics without their knowledge.
Co-investment and information rights
A side letter can grant an investor the right to see future deals before they are offered broadly, a seat or observer role in the manager’s own advisory activities, or more detailed and more frequent reporting than the standard investor update. These terms often go to an investor who is expected to commit to multiple SPVs over time, not just the current one.
Fee and excuse rights
Large or strategic investors sometimes negotiate a reduced fee or a smaller carried interest allocation on their own commitment, or an excuse right that lets them sit out a specific investment if it would conflict with their own regulatory or policy restrictions, such as an investment that would create a conflict for a bank-affiliated or government-affiliated investor. For more on how a standard carry split is usually set before a side letter changes it for one investor, see Understanding Common Carry Percentage.
A worked example of an MFN clause in practice
Suppose an SPV’s standard terms carry a 20 percent carried interest, and an early institutional investor negotiates a side letter with an MFN clause as a condition of committing $2 million. Three months later, the manager grants a different investor a reduced 15 percent carry in exchange for a $3 million commitment. The MFN clause requires the manager to notify the first investor of the more favorable carry term, and that investor can then elect to have its own carry reduced to 15 percent as well. The manager now has two investors at the lower rate instead of one, which is the cost of granting an MFN clause in the first place. These figures are hypothetical.
How a side letter interacts with the operating agreement
A side letter generally states that it controls over the operating agreement for that specific investor to the extent the two conflict, but it cannot rewrite provisions that protect other investors or the SPV’s own compliance with securities law, such as its ownership limits or accredited investor requirements. A well drafted side letter says explicitly what it changes and confirms every other term of the operating agreement stays in force. For background on the terms a side letter typically sits alongside, see Tailored SPV Fund Documents.
Why sponsors grant side letters
A manager raising an SPV often needs one or two large or strategic checks to make the deal work, and those investors frequently have their own internal requirements, whether regulatory, policy-driven, or simply a matter of negotiating leverage that comes with writing a larger check. Granting a side letter lets the manager meet that investor’s specific need without renegotiating the standard operating agreement that every other investor already signed.
Risks and limits of side letters
Side letters create real obligations the manager has to track alongside the standard operating agreement, and a manager running several SPVs with different side letters for different investors needs a system to remember which investor gets which terms. An MFN clause in particular means every new side letter the manager grants can trigger a notice obligation to earlier investors who hold their own MFN rights, so sponsors should track side letters centrally rather than case by case. Side letters also cannot be used to disadvantage other investors, and a term that effectively takes value away from the rest of the SPV, rather than simply changing terms between the manager and one investor, is more likely to draw a legal challenge.
Negotiating a side letter as an investor
An investor asking for a side letter should be specific about what it actually needs, whether that is an MFN clause, an excuse right tied to a defined policy, or a particular reporting cadence, rather than asking for broad, undefined favorable treatment that is harder for a manager to grant and track. Smaller investors in an SPV rarely receive side letters at all, since the negotiating leverage that produces one usually comes from check size or a standing relationship with the manager across multiple deals. For more on what LPs typically negotiate for and expect, see Understanding Limited Partners in Private Equity.
Comparing common side letter terms
| Term | What it gives the investor | What the manager should track |
|---|---|---|
| Most favored nation clause | Notice of, and the option to elect, better terms granted to a later investor | Every side letter granted afterward, to know who else needs notice |
| Co-investment or information rights | Early look at future deals or more frequent reporting | Which investors are owed advance notice or extra reports |
| Fee or carry reduction | Lower cost of participating in the specific SPV | Whether an MFN holder elsewhere is entitled to the same reduction |
| Excuse right | Ability to sit out a specific investment tied to a defined conflict | Whether excusing that investor changes the capital available for the deal |
Common side letter mistakes
- Granting a side letter without checking whether an existing MFN holder is now owed notice.
- Writing vague language that does not say exactly which sections of the operating agreement the side letter changes.
- Tracking side letters in the same file as the subscription documents instead of a system that flags MFN triggers across the portfolio.
Frequently asked questions
Do all investors in an SPV get the same side letter terms?
No. A side letter binds only the manager and the specific investor who signed it, unless another investor holds a most favored nation clause that lets it elect the same terms.
Can a side letter change how much carried interest an investor pays?
Yes, a side letter can reduce a specific investor’s fee or carried interest allocation, though this generally applies only to that investor’s own economics and does not change the split for anyone else in the SPV.
Is a side letter legally binding?
Yes. It is a contract between the manager and the investor and is enforceable on the same basis as the operating agreement itself, provided it does not attempt to override provisions the operating agreement reserves for all investors collectively.
Do side letters have to be disclosed to other investors?
Not automatically, unless another investor holds a most favored nation clause that entitles it to notice of more favorable terms granted elsewhere. Absent an MFN right, side letter terms are typically kept between the manager and that one investor.
How Syndicately fits
Syndicately administers an SPV’s subscription documents and other fund paperwork, and helps a manager running multiple vehicles keep each investor’s specific terms organized in one place. See how Syndicately supports fund document administration across a portfolio of SPVs.
This article is general information, not legal advice. Side letter terms should be drafted and reviewed by securities counsel to confirm they are enforceable and do not conflict with the SPV’s other obligations.
