Side Letters and MFN Clauses
Definition
A side letter is a separate agreement between a private fund's general partner and one limited partner that modifies the fund's terms for that investor alone. Large or early investors use them to obtain management fee and carry discounts, co-investment rights, seats on the advisory committee, enhanced reporting, excuse rights that let them opt out of investments that breach their policies, transfer rights, and regulatory representations. A most-favored-nation (MFN) clause is the mechanism that keeps the practice from fragmenting the fund: it gives each limited partner the right to see the side-letter terms granted to others and to elect any that are not tied to a larger commitment, a specific regulatory status or a particular investor's circumstances. MFN rights are usually tiered by commitment size, so a $5 million investor can elect terms given to investors at or below $5 million but not those given to a $100 million anchor, and platform feeders that aggregate many small investors typically hold weak or no MFN rights.
Why it matters
The terms in a fund's PPM are the terms nobody negotiated. The investors who supplied most of the capital hold side letters that improve on them, and the MFN system decides how far those improvements reach down the investor list. An individual entering through a platform is at the bottom of that list twice: too small for an MFN right in the master fund, and dependent on the feeder for whatever the platform negotiated on the pooled commitment. The questions that matter are simple and rarely asked: does the feeder hold an MFN right, what did it elect, and does the platform's own fee discount from the manager reach the investor or stop at the platform.
Common misconceptions
- •Side letters are not secret in institutional funds. MFN clauses require the manager to compile and circulate them to eligible investors after the final close; what varies is who is eligible.
- •An MFN right does not deliver every side-letter term. Size-based, regulatory and investor-specific provisions are carved out, and the election is usually all-or-nothing per side letter rather than a menu.
- •A fee discount to a platform is not automatically a discount to the platform's investors. The platform may retain the difference as its own economics; the feeder's fee disclosure is where that shows.
- •The vacated SEC rules did not make preferential terms illegal. They are lawful and common; the rules would have added disclosure and two prohibitions, and their vacatur restored the prior position.
Technical details
What a side letter package typically contains
Economics: management fee reduction, carried interest reduction, offset of placement fees, fee-free or reduced-fee co-investment allocation.
Governance: limited partner advisory committee (LPAC) seat, observer rights, notice and consent on conflicts, key person and for-cause notices.
Information: quarterly reporting in a specified format, portfolio company financials, ESG and diversity data, access to valuation policies and auditor letters.
Structural: excuse rights (the investor may decline to fund investments in prohibited sectors), exclusion rights (the manager may exclude an investor from an investment for regulatory reasons), transfer and withdrawal rights for regulatory triggers, freedom-of-information carve-outs for public pensions.
Representations: confirmation of the manager's registration status, compliance with sanctions and anti-corruption laws, and placement agent disclosures.
How the MFN election works
After the final close, the manager delivers a compendium of side-letter provisions to each investor entitled to MFN, redacted of names, and often grouped by commitment tier.
Each eligible investor elects, within a stated period (often 15 to 30 days), the provisions it wishes to receive; the election is commonly on a letter-by-letter basis.
Carve-outs: provisions granted to investors with larger commitments; provisions required by the electing investor's own law or regulatory status that do not apply to the elector; co-investment rights; LPAC seats; and any provision the manager designates as non-MFN at the time of grant.
Tiers: typical thresholds might be $25 million, $50 million and $100 million; an investor may elect terms granted at its tier or below.
Where platform investors stand
Access funds and feeders commit as a single limited partner. If the aggregate is large enough, the feeder may sit in a high MFN tier and elect strong terms; whether those terms are passed through (for example, a fee discount) is a question for the feeder's own disclosure.
Some platforms negotiate a platform-wide side letter with a manager covering all feeders into that manager's funds; the platform review should say what it contains, if the platform discloses it.
Individuals hold no side letter with the master fund and no MFN right of their own; their document is the feeder's subscription agreement.
AltStreet's iCapital review sets out what the platform discloses about its fee arrangements with managers; the access fund page explains the vehicle.
Regulatory context
Form ADV Part 2A requires an adviser to describe conflicts, including preferential treatment of some investors, in general terms.
The SEC's private fund adviser rules (adopted August 2023, vacated by the Fifth Circuit in June 2024) would have prohibited preferential redemption and portfolio-information rights with a material negative effect on other investors and required written disclosure of all preferential terms; their vacatur means neither applies as law, though many managers kept the disclosure practice.
Institutional Limited Partners Association (ILPA) model documents provide a market template for MFN scope and tiers; a manager's departure from the template is a negotiating position, not a violation.
How investors apply the term
Investors usually apply this term by tying the definition back to the controlling documents and then asking which cash flows, rights, restrictions, or valuation assumptions it changes. A useful review looks at the term alongside fees, leverage, liquidity, reporting frequency, and manager discretion rather than treating it as a standalone concept.
The practical diligence test is simple: identify who benefits if the assumption is wrong, who has control when conditions change, and what evidence the investor receives after closing. Terms that cannot be reconciled to documents, cash movements, and monitoring data should be treated as marketing shorthand until proven otherwise.
Frequently asked questions
- What is a side letter in a private equity fund?
- A private agreement between the fund's manager and one investor that changes the terms for that investor. The fund's limited partnership agreement applies to everyone; the side letter adds or overrides terms for the signatory, most often a fee discount, a right to co-invest alongside the fund, a seat on the advisory committee, extra reporting, or the right to be excused from investments that conflict with the investor's policies.
- What is a most-favored-nation clause?
- An MFN clause gives an investor the right to review the side letters the manager has granted to others and to elect any of their provisions for itself. It is the check that keeps side letters from giving some investors materially better economics than others. Nearly all MFN clauses carve out terms that depend on commitment size, regulatory status (for example, provisions for ERISA plans or sovereign funds), or facts specific to one investor, and most restrict election to terms granted to investors of the same or smaller size.
- What terms are commonly granted in side letters?
- Economic: management fee discounts (often 10 to 50 basis points for large or first-close investors), carry reductions, fee-free co-investment. Governance: advisory committee seats, consent rights, notice of key person or for-cause events. Information: portfolio-company-level reporting, ESG data, tax information in a preferred format. Structural: excuse and exclusion rights, transfer consent, confidentiality carve-outs for public bodies, and representations about the manager's regulatory status.
- Can a small investor benefit from side letters?
- Only through the MFN tier that matches its size, and only if it has an MFN right at all. An investor below the threshold at which the manager grants MFN (commonly $10 to $25 million in institutional funds) has no election right and may not see the side letters. Investors in a platform feeder have whatever right the feeder negotiated; some platforms obtain MFN at the feeder level on behalf of their aggregate commitment, many do not.
- What did the SEC's private fund adviser rules change?
- The 2023 rules would have prohibited preferential redemption and information rights that harm other investors and required disclosure of all other preferential terms to every investor before they commit. A federal appeals court vacated the rules in June 2024, so they are not in force, but the disclosure practice they described (a summary of side-letter terms provided to prospective investors) has been adopted by many managers, and some LPAs now require it. Ask for the summary.
- Are side letters relevant to Regulation A or Reg CF investments?
- Rarely. Those offerings sell the same security on the same terms to every purchaser under an offering circular or Form C, and the issuer cannot give one investor different rights in the same class. Side letters belong to private funds sold under Regulation D, including the access funds and feeders through which platforms offer institutional funds to individuals.