Side Letter
Side letters grant specific LPs terms outside the LPA (economics, reporting, governance). Allocators focus on systemic impact—fairness, disclosure, and MFN mechanics—because side-letter sprawl creates information asymmetry and governance fragmentation.
Side letters are bilateral agreements granting specific LPs rights or economics beyond the main fund documents. They are a critical — and often opaque — component of fund governance.
From an allocator perspective, side letters are less about preference and more about fairness, transparency, and systemic risk.
How allocators define side letter risk drivers
Allocators evaluate side letters via:
- Economic impact: fee breaks, rebates, carry tweaks
- Information asymmetry: preferential reporting/access
- Governance imbalance: consent/veto rights, advisory positions
- MFN exposure: whether terms must be shared/electable
- Operational complexity: tracking obligations and compliance risk
- Aggregate effect: cumulative impact across the LP base
Allocator framing:
“Do side letters enhance alignment — or quietly fragment it?”
Where side letters matter most
- oversubscribed funds with heavy negotiation
- first-close vs later-close dynamics
- LP bases with mixed sophistication
- multi-jurisdiction LPs with regulatory constraints
How side letters change outcomes
Disciplined side letter usage:
- handles regulatory realities without breaking fairness
- supports anchor participation cleanly
- preserves trust through structured disclosure
Excessive side letter usage:
- creates governance inequality
- introduces MFN friction and admin burden
- reduces allocator trust and slows re-ups
How allocators evaluate side letter hygiene
Conviction increases when managers:
- maintain a side letter matrix (rights grouped + tracked)
- cap or standardize governance-altering provisions
- disclose MFN-eligible terms consistently
- explain aggregate economic impact and operational controls
What slows allocator decision-making
- undisclosed governance side letters
- MFN language that is technically present but practically unusable
- conflicting consent rights across LPs
- weak operational workflows to track obligations
Common misconceptions
- “Side letters are harmless perks.” → aggregate effects matter.
- “MFNs fix everything.” → only if elections are clean and disclosed.
- “Only large LPs care.” → smaller LPs carry systemic downside.
Key allocator questions during diligence
- How many side letters exist, and what do they cover?
- Which provisions are MFN-eligible and how are they disclosed?
- Are governance rights standardized or bespoke?
- How do you monitor side letter compliance operationally?
- What is the aggregate economic impact of fee breaks?
Key Takeaways
- Side letters reshape governance quietly
- Transparency matters more than customization
- Aggregate effects define allocator risk perception