Side Letters in Venture Capital

Introduction

Side letters are increasingly common in venture capital and private fund structures. As one legal analysis put it, they have become "ubiquitous" in private equity and venture funds and have grown substantially in length and complexity over time. Washington University Law Review, 2023.

Since we named our platform after the notorious side letter, we thought it was time to share a perspective on what's standard, what's negotiable, and what's best avoided. This guide is written primarily for LPs, with a sidebar at the end offering guidance for GPs, especially emerging managers navigating these requests for the first time.

In general, particularly when investing in newer or smaller funds where alignment is clear, we believe LPs should be careful not to overreach. These are always long-term partnerships that should not be engineered for short-term gains.

Emerging managers shouldn't be hamstrung by side letters filled with unnecessary or misaligned terms. That's not just good for GPs, it's in the LP's best interest, too.

What's Standard (and What's Not) in a Side Letter?

In venture capital, a side letter is a contractual agreement between a limited partner and a fund that grants that LP specific rights beyond what's included in the standard limited partnership agreement.

Sometimes these letters are required, triggered by tax, reporting, or internal governance needs. Other times they're used to negotiate preferential terms. But while side letters offer LPs flexibility, they can also introduce fund-level risk: creating complexity, misalignment, or governance friction, especially in smaller funds.

At The Side Letter, we track how LPs and GPs navigate these agreements. This guide outlines what's considered market standard, what's tolerable, and what LPs should think twice about asking for.

What Belongs in the LPA (Not a Side Letter)

Some terms are so common or broadly applied that they should be embedded in the fund documents, not carved out for select LPs.

• Most Favored Nation (MFN) clauses
• SPV / Co-investment first-look provisions
• Concentration limits, for example no more than 15% of capital in one deal
• Industry restrictions such as weapons, gambling, or fossil fuels
• Asset class restrictions such as public stocks, crypto, or derivatives
• Jurisdictional exclusions for certain countries or sanctioned regions
• Vehicle stacking restrictions, for example a fund can't invest in other funds with carry or fees

When these apply to all LPs, they should be codified in the LPA. Side letters are best reserved for specific carveouts, not core fund mechanics.

Market Standard Side Letter Provisions for LPs

These provisions are commonly requested and often granted, especially by institutional LPs or those with governance constraints:

• MFN Rights, sometimes with thresholds or opt-in caps
• Enhanced Reporting
• quarterly GAAP audits, DEI metrics, ESG tracking
• Notification Rights, including key person events, early exits, and successor funds
• Excusal Rights for specific sectors or geographies
• Tax Structuring Provisions such as UBTI blockers and ECI carveouts
• Transfer Rights with GP consent
• Jurisdiction-Specific Language for ERISA or sovereign wealth funds

Most GPs are prepared for these asks. They increase admin complexity but don't typically impact fund performance or governance.

Common (But Not Always Accepted) Requests

These provisions are less universal, but not unreasonable. LPs should be thoughtful about when and how to ask.

• Co-Investment / Pro-Rata Priority Language
• Most GPs avoid contractual guarantees, but may acknowledge informal preference for LPs.
• LPAC Participation Rights
• Often tied to check size or early commitment.
• Successor Fund Capacity
• Priority allocation in Fund II for anchor LPs or early backers.
• Custom Reporting Templates
• Common with family offices, but creates reporting overhead.
• Discounted Fees for Early or Large LPs
• For example, 1% management fees for first-close LPs committing $2M+.
• These are often granted when the LP is strategic, anchoring a close, or playing an outsized role in fundraising momentum.

What LPs Should Be Cautious About Requesting

Some asks may seem benign but can harm fund operations or violate fair treatment. GPs may rightly resist:

• Custom Capital Call Schedules
• Creates major accounting and liquidity complexity, especially for small funds.
• Transfer to Affiliates Without GP Consent
• Risky for compliance, governance, and control over the LP base.
• Fund-Level Audit Requirements for Sub-$25M Funds
• Easily $40K+ in annual cost that materially affects fund economics.
• Access to LP Lists or Identities
• Violates confidentiality and introduces reputational risk.
• Liquidity or Redemption Rights
• Uncommon in closed-end VC structures and can spook other LPs.
• Guaranteed Co-Investment Rights
• Hard to operationalize fairly and misaligns deal allocation.
• Investment Committee Voting Rights
• Extremely rare and often sounds better than it works in practice.
• Management Company or Operating Company Ownership
• More common in GP staking, not standard side-letter territory.

Mandate-Driven LPs

It's also worth noting that some LPs, such as SBICs, CVCs, and public entities like The New Mexico State Investment Council, have non-negotiable reporting or governance requirements driven by their internal mandates. These are less a matter of negotiation and more about ensuring fund structures can accommodate statutory or compliance needs.

How To Make Asks Without Becoming the Problem

• Smart LPs tailor their asks to fund size, strategy, and stage.
• Prioritize what's tied to fiduciary or internal compliance obligations.
• Be willing to walk away from side letters that add minimal benefit.
• Avoid using MFN as a bludgeon. Use opt-in MFNs or carveouts for certain terms.
• Don't ask for terms you wouldn't be comfortable seeing in a data room.

Anchor LPs may have more negotiating power, but should still calibrate asks based on GP bandwidth.

Note: Strategies for GPs Negotiating Side Letters

LPs aren't always aware of how side letter terms ripple through fund operations. Here are some polite, yet effective strategies for GPs negotiating side letters while maintaining sanity.

• Set a Threshold: "No side letters for checks under $1M."
• Use Policies: "All early-close LPs get 1% fees, no custom discounts."
• Centralize Terms: "We prefer to include broadly requested provisions in the LPA to ensure fairness."

Track Everything: Use Google Sheets, Airtable, or your fund admin's tools to track side letter terms.

Structure MFNs Carefully: Make them forward-looking or limit opt-ins to LPs above a commitment threshold.

The best defense is clarity. GPs who communicate side letter policies early avoid back-channel negotiations and costly precedent.

Closing Thought

Side letters are powerful tools, but only when used with intention. For LPs, they're a way to align fund terms with institutional needs. For GPs, they're a trust exercise in navigating power dynamics and complexity.

At The Side Letter, we believe transparency benefits both sides. If you're an LP negotiating a side letter, or a GP trying to draw the line, The Side Letter exists to help you benchmark what's truly "market."

Disclaimer: This article is for informational purposes only and does not constitute legal, financial, or investment advice. For legal or regulatory questions, consult qualified advisors.