Side letter essentials for emerging managers

Author:

The Carta Team

|

Read time:

9 minutes

Published date:

March 9, 2026

Side letter agreements provide tailored terms outside main contracts. Explore common clauses, benefits and management tips in private fund deals.

Contents: What is a pro-rata right in a side letter?

What is a side letter in private funds?

A side letter is a binding agreement that grants a specific investor, known as a limited partner (LP), special rights or terms that are not available to all other investors in the fund. These agreements are confidential and tailored to the specific relationship between the fund and that investor.

You use a side letter to a primary contract like the limited partnership agreement (LPA) in order to accommodate an important LP’s unique needs. This allows you to secure their capital without having to change the rules for everyone else in the fund. It’s a standard practice in private fund investing to help close deals with institutional investors who have specific requirements.

Common side letter rights and terms for fund managers

What is a most favored nation (MFN) clause?

A most favored nation (MFN) clause is a right for an LP to receive the benefit of more favorable terms subsequently granted to other investors in the same fund. It gives an LP the right to see the terms other LPs have negotiated in their own side letters.

What are information and reporting rights?

Information rights allow an LP to demand more frequent or detailed reports than what you provide to the rest of the fund. While standard investors might receive quarterly updates, an investor with these rights might require monthly data or specific portfolio analytics.

Do LPs negotiate for fee discounts?

While the classic 2-and-20 fee structure remains the norm, it is common for certain types of investors to negotiate for lower fees or a reduction in costs. For example, some managers of smaller venture funds may be willing to reduce their carried interest to as low as 15% as a way to attract LP interest.

• Management fee discounts
• Carried interest discounts

Can LPs ask for special transfer rights?

A transfer rights clause gives an LP more flexibility to sell or transfer their interest in the fund to another party via secondary markets (platforms where investors buy and sell existing interests in private funds).

What are co-investment and excuse rights?

These two rights control an LP's participation in specific deals within your portfolio. They allow investors to either opt out of deals they cannot touch or double down on deals they love.

• Excuse rights: These allow an LP to opt out of a specific investment if it violates their internal rules or ethical mandates.
• Co-investment rights: These give an LP the opportunity to invest additional capital directly into a portfolio company alongside the fund.

How GPs use side letters when investing in startups

When you, as a GP, invest your fund’s capital into a startup, the roles reverse. You will use a side agreement to secure important rights for your fund from the portfolio company.

• Pro-rata rights: This guarantees the fund an opportunity to make a follow-on investment in the startup's future financing rounds to maintain its ownership percentage.

The operational challenges of managing side letters

A private fund lifecycle can last a decade or longer. Relying on spreadsheets and memory to track these complex, long-term obligations is a significant operational risk.

You might have dozens of side letter arrangements across multiple funds. Each letter might contain different variations of MFN clauses, reporting requirements, and fee structures. This is where a centralized system becomes essential. Carta Fund Administration is a purpose-built platform designed to solve this problem.

A checklist for managing side letter compliance

You can manage the complexity of side letters by following a consistent process.

• Establish your "house" terms
• Track every agreement
• Run the MFN election process
• Centralize and automate
• Review before wind-down

Frequently asked questions about side letters

Are side letters legally enforceable?

Yes, a properly drafted and executed side letter agreement is a legally binding contract. It is enforceable in court, provided it meets the standard requirements for contract formation.

What is a pro-rata right in a side letter?

A pro-rata right is a clause that allows an investor to maintain their initial ownership percentage in a portfolio company. It gives them the option to participate in subsequent funding rounds. This protects the investor from being diluted as the company issues more shares to new investors.