A side letter is a private, supplementary agreement between a fund manager or company and an individual investor that modifies or grants special terms beyond what appears in the standard partnership agreement or investment documents. These confidential arrangements allow investors with significant leverage—typically large institutional investors or high-net-worth individuals—to negotiate customized provisions that address their specific requirements or concerns.
Why It Matters
Side letters create a two-tiered system within investment structures, where some investors receive preferential treatment that others don't even know exists. For angel investors considering joining a fund or syndicate, understanding whether side letters are in play is critical because they can affect everything from your voting rights to your share of returns. A pension fund might negotiate a side letter guaranteeing quarterly liquidity options or fee discounts, fundamentally changing the economics for that investor while leaving standard limited partners with the original terms. This practice, while common in private equity and venture capital, raises fairness questions and can create alignment issues if not properly managed.
Example
A university endowment commits $50 million to a venture capital fund with a standard 2% management fee and 20% carry structure. Through a side letter, the endowment negotiates a reduced 1.5% management fee due to the size of their commitment, additional reporting on ESG metrics required by their investment committee, and a "most favored nation" clause ensuring they automatically receive any better terms granted to future investors. Meanwhile, a smaller angel investor contributing $500,000 pays the full 2% fee and receives only the standard quarterly reports. Neither the main fund documents nor the smaller investor's subscription agreement mentions these special arrangements.
Related Terms
Most Favored Nation Clause, Management Fee, Carried Interest