Side Letters in Private Market Funds
Learn how side letters in private equity define special arrangements that impact reporting, fees, and investor rights.
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Side letters are powerful tools for investors, but are often overlooked in private equity funds. They are confidential agreements that fall outside the terms of the primary investment documents. Understanding how they work helps both fund managers and investors maintain fairness, transparency, and compliance.
What are Side Letters in Private Market Funds?
In private equity, side letters serve as negotiated add-ons that customize specific terms for individual investors. Instead of rewriting the main Limited Partnership Agreement (LPA), fund managers and investors use side letters to document tailored arrangements, such as fee adjustments, reporting obligations, or tax provisions, that apply only to that investor.
In simple terms, think of a side letter as a “special addition” to a standard contract. For example, suppose a large institutional investor, like a pension fund, commits a significant amount to a fund. In that case, they might negotiate a side letter that gives them reduced management fees or more frequent performance updates.
Striking a balance between flexibility and standardization, side letters allow funds to meet distinct investor requirements—such as co-investment opportunities or reporting preferences—without disrupting the core fund terms. These agreements are common in private equity and venture capital, especially among larger or strategic investors.
Common Side Letter Requests in Private Market Funds
Fee discounts or carry adjustments
Key investors (anchor LPs) may negotiate lower management fees or carried interest on their share of the fund.
Enhanced reporting
Some LPs request more detailed or more frequent reports, such as quarterly valuations or custom financial data.
Co-investment opportunities
Side letters may grant investors the option to invest alongside the fund in select deals, often through a Special Purpose Vehicle (SPV).
Excusal rights
LPs may request the right to opt out of certain investments that conflict with their own compliance policies or mandates.
Most-Favored-Nation (MFN) clauses
These allow investors to receive any more favorable terms granted to others in similar agreements, ensuring fairness across investors.
How Side Letters Affect Fund Terms and Operations
While side letters are practical tools for investor relations, they can also initiate complexities. Different terms for different investors can pose operational and legal challenges if not carefully managed. Fund managers must ensure that obligations in side letters align with the LPA and do not conflict with the fund’s existing terms.
Proper tracking, compliance, and communication are essential to avoid risks and maintain fairness across the investor base. When used responsibly, side letters in private market funds help attract institutional capital and strengthen investor relationships, while preserving transparency and trust in fund operations.
Frequently Asked Questions:
Why do investors request side letters in private market funds?
Investors request side letters to customize the terms of their participation in a fund. Large or regulated investors may have unique tax, legal, or reporting requirements that differ from other limited partners.
Are side letters legally binding?
Yes. Side letters are legally enforceable agreements once both the fund manager and investor sign them. Although they are outside the main fund documents, they carry the same contractual weight.
How do fund managers keep track of multiple side letters?
Many fund managers use fund administration platforms or specialized compliance tools to manage their side letters. These systems help map each investor’s specific rights and obligations to ensure consistent compliance and reporting.
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