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.

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.

The main fund agreement, the LPA, sets the general rules for how the fund operates. However, large institutional investors often have internal policies or regulatory requirements that the standard LPA does not cover. A side letter bridges this gap by addressing those specific requirements directly.

When you sign a side letter, you are creating a separate contract that overrides the LPA for that specific investor. This means you must track these unique obligations separately from your general fund operations. Failure to do so can lead to a breach of contract.

Common side letter rights and terms for fund managers

Now that you understand the purpose of a side letter, it’s important to recognize the common provisions you will likely encounter when fundraising. Institutional investors often have a standard set of requests they present to every fund manager after reviewing the investor pitch deck. Understanding these terms in advance helps you negotiate effectively and protect your firm's interests.

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. If they see a term they prefer, they can elect to receive that same treatment.

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. This is often necessary for their own internal compliance or regulatory reasons.

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.

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). Standard fund agreements usually restrict an investor's ability to leave the fund before it winds down. This side letter provision provides an exception for specific LPs who may need liquidity sooner.

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. For example, a university endowment or pension fund may be prohibited from investing in tobacco, firearms, or gambling companies.
• Co-investment rights: These give an LP the opportunity to invest additional capital directly into a portfolio company alongside the fund. This is often attractive to LPs because these direct investments, often structured via a special purpose vehicle (SPV), frequently come with reduced fees compared to the main fund.

The operational challenges of managing side letters

A private fund lifecycle can last a decade or longer, as it takes many years for investments to mature and generate returns for LPs. Relying on spreadsheets and memory to track these complex, long-term obligations is a significant operational risk. If a key team member leaves, the knowledge of these specific agreements might leave with them. A missed obligation can damage an LP relationship and your firm's reputation.

A checklist for managing side letter compliance

You can manage the complexity of side letters by following a consistent process. Frame this as a simple workflow to follow for every fund you launch. This helps ensure that no obligations are missed as your firm grows.

• Establish your "house" terms: Before you start fundraising, work with your fund’s legal counsel or law firm to decide which side letter requests you are willing to grant. Create standard language and templates for these terms so you are not drafting from scratch every time. This ensures you are receiving sound legal advice before finalizing any terms.
• Track every agreement: During fundraising, maintain a master log of all agreed-upon side letter terms for each LP. Do not wait until the fund closes to organize this data.
• Run the MFN election process: Immediately after your final close, you must conduct the MFN election process. This involves disclosing the relevant terms to eligible LPs and documenting their choices.
• Centralize and automate: Use a dedicated fund administration platform to serve as the single source of truth for all side letter obligations. This allows you to automate compliance checks and reporting where possible.
• Review before wind-down: Before dissolving the fund, conduct a final review of all side letters. You must ensure every long-term obligation, including any potential waiver of specific requirements, has been fulfilled before closing the books.

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.