Side Letters in Private Funds: Common Terms, MFN and Tracking

A side letter is a separate agreement between a private fund (usually signed by the general partner) and a specific investor that adds to or modifies that investor's rights under the limited partnership agreement. Side letters let a GP accommodate an investor's regulatory, tax, reporting or economic requirements without changing the LPA for everyone. They are standard in institutional fundraising, and a fund with dozens of LPs may have dozens of side letters.

The drafting is a legal exercise. Keeping the promises is an operational one, and that is where most side letter problems actually arise. This guide covers both.

Why side letters exist#

The LPA is a single document that applies to every limited partner. But investors are not uniform:

• A public pension plan may be subject to open-records laws and need specific confidentiality language.
• A sovereign wealth fund may need to preserve sovereign immunity.
• A tax-exempt investor may need assurances about unrelated business taxable income.
• A large anchor investor may have negotiated a fee discount in return for committing early.
• An investor subject to sanctions or ESG policies may need excuse rights from certain investments.

Rewriting the LPA for each of these would be impractical and would give every investor rights they do not need. A side letter handles each request bilaterally.

Common side letter provisions#

Most provisions fall into four groups. The table lists typical examples; the specific terms in any fund depend on negotiation.

Excuse rights#

An excuse right lets an investor decline to fund a particular investment because of law or internal policy, for example a prohibition on investing in certain industries. The LPA usually provides the mechanics; the side letter specifies which categories the investor may be excused from. Excuse rights affect capital call calculations, because the excused investor's share is reallocated to other LPs or the investment is sized down.

Co-investment rights#

Investors often ask for priority or notice rights for co-investment opportunities. These are usually framed as non-binding, since the GP must also manage allocation fairness across investors, but they create expectations that need to be tracked.

Transfer rights#

Some investors negotiate pre-approval to transfer their interest to affiliates or successor entities. This matters in the secondary market and in the investor's own restructuring.

How most-favored-nation clauses work#

A most-favored-nation (MFN) clause entitles an investor to receive the benefit of terms granted to other investors in their side letters, subject to conditions. MFN clauses are what turn side letters from bilateral deals into a fund-wide exercise.

A typical MFN process:

1. Size tiers. The MFN usually lets an investor elect terms granted to investors with commitments equal to or smaller than its own. An investor committing $20M can elect terms given to others at $20M or below, but not terms given to a $75M anchor.
2. Carve-outs. Certain terms are excluded from MFN entirely. Common exclusions include advisory committee seats, terms tied to a specific investor's legal or regulatory status, fee terms tied to commitment size or timing, and co-investment rights.
3. Compendium. After the final close, the GP (often with counsel) prepares a compendium of all side letter terms, grouped by the commitment level at which they were granted.
4. Election. Each MFN investor receives the portion of the compendium it is eligible for and has a set period to elect provisions.
5. Bundling. Some MFN clauses require an investor electing a term to accept any related conditions or obligations attached to it.
6. Recording. Elected terms become part of that investor's side letter and must be tracked like any other obligation.

Worked example#

Assume a hypothetical fund with these side letters:

Investor E commits $30M with an MFN clause. E may elect B's ESG report and C's key-person notice, since both were granted at $30M. E cannot elect A's fee discount (granted to a larger investor) or the LPAC seat (carved out), and D's confidentiality language is excluded because it addresses D's legal status. If E elects both eligible terms, the fund now owes ESG reporting to two investors and expedited key-person notice to two investors. Each of these needs to be in someone's workflow.

Regulatory context in 2026#

In August 2023, the SEC adopted Private Fund Adviser Rules that would have restricted certain preferential treatment, including preferential redemption and information rights that could have a material negative effect on other investors, and required disclosure of preferential terms to prospective and current investors. In June 2024, the U.S. Court of Appeals for the Fifth Circuit vacated those rules in full, so the preferential treatment rule does not apply.

That does not leave side letters unregulated. Obligations that predate the vacated rules still apply:

• Antifraud provisions. Advisers to pooled investment vehicles remain subject to Rule 206(4)-8 under the Advisers Act, which prohibits misleading statements to investors and prospective investors. Granting materially better liquidity or information to one investor without adequate disclosure can raise issues under it.
• Fiduciary duty. Advisers owe a duty of care and loyalty to the fund, which bears on conflicts created by preferential terms.
• Disclosure in offering documents. PPMs and LPAs typically disclose that the GP may enter into side letters granting different terms, and many investors expect a summary of material terms.

Many LPs continue to ask for side letter disclosure as a matter of good practice, and industry guidance such as ILPA's principles encourages transparency on side letter terms. For more on how the vacated rules affect other areas, see private fund adviser rules.

Negotiating side letters: guidance for GPs#

• Set a policy before fundraising. Decide which terms you will offer, at what commitment levels, and which terms you will never give. Ad hoc concessions compound through the MFN.
• Keep a running compendium. Logging each term as it is agreed, with the commitment level and any carve-out, makes the post-close MFN process far faster.
• Watch the economics. Fee discounts granted to several investors can materially reduce management fee revenue. Model the blended fee before agreeing.
• Avoid operationally impossible promises. Custom reporting deadlines that are earlier than your administrator can produce, or bespoke formats for every investor, become recurring liabilities.
• Coordinate with the LPA. Side letters should supplement the LPA, not contradict it. Conflicts create ambiguity about which document controls.

Tracking obligations after signing#

Once signed, every side letter creates ongoing obligations. A practical tracking approach:

1. Extract every obligation into a structured register: investor, provision, type (reporting, notice, consent, economic, restriction), trigger, deadline and owner.
2. Link economic terms to calculations. Fee discounts must flow into the management fee calculation, and excuse rights into capital call allocations.
3. Attach reporting obligations to the reporting calendar, so the quarterly cycle includes every extra deliverable.
4. Map event-driven obligations to triggers. Key-person notices, transfer consents and certain regulatory notices depend on events, not dates, and are the ones most often missed.
5. Review at least annually, and whenever a new fund or vehicle is added, since terms sometimes extend to successor funds or co-investment vehicles.

Missing a side letter obligation is rarely catastrophic on its own, but it erodes trust with exactly the investors who negotiated hardest. Strong investor relations depends on delivering every promise without being reminded.

How Privatis helps#

Privatis tracks side letter provisions and MFN elections for each investor, so economic terms flow directly into management fee calculations and capital call allocations. Reporting and notice obligations sit alongside ILPA-style investor reporting and the compliance filings calendar, documents are delivered through the LP portal, and every change to an investor's terms is recorded in the audit trail.

Side letter terms have legal and regulatory consequences that vary by fund and investor, so confirm specific provisions with fund counsel.