Side Letter
A side letter is an agreement between a private-fund sponsor or related party and a specific investor that grants, clarifies, modifies or supplements rights or obligations beyond the generally applicable fund documents.
A side letter creates investor-specific terms
Private funds often have one LPA that applies broadly to the partnership, but some investors negotiate separate side letters. These agreements can grant or clarify rights that are not given identically to every LP.[1][3]
Common subjects include:
- regulatory or statutory requirements
- tax representations
- enhanced reporting
- notice rights
- fee discounts
- excuse rights
- transfer provisions
- advisory-committee rights
- confidentiality
- co-investment processes
- most-favored-nation rights
The effect depends on the actual language and how the side letter interacts with the LPA and subscription documents.
Why institutional investors use them
A pension plan, sovereign wealth fund, insurance company or other institution may face legal or policy constraints that a standard LPA does not address. A side letter can tailor the relationship without rewriting the core agreement for every investor.
The same flexibility can also create information asymmetry. If one LP receives preferential liquidity, fees or information, other investors may care about the economic consequences.
SEC examination history matters
SEC examination staff reported in 2020 that some private fund advisers had granted select investors preferential liquidity terms through side letters without adequate disclosure, creating potential harm to other investors.[1]
The SEC later adopted specific private-fund preferential-treatment rules in 2023. Those rules were vacated by the U.S. Court of Appeals for the Fifth Circuit in June 2024, and the SEC states that the newly adopted private-fund rules are no longer in effect.[2]
That vacatur is important. A current glossary should not describe the 2023 preferential-treatment rule as operative law.
It also does not mean side letters are outside existing antifraud, fiduciary, contractual or other applicable requirements.
Example
Assume Fund X has a standard management fee schedule. A large institutional LP negotiates a side letter that reduces its fee after a specified commitment threshold and gives additional tax-reporting notices.
Another LP without that letter remains governed by the general fee schedule and reporting provisions.
The two investors own interests in the same fund but can have different contractual rights.
Side letter versus LPA amendment
A formal LPA amendment changes the partnership agreement according to its amendment procedures and can apply broadly.
A side letter usually applies to a particular investor or subset of investors. It may state that its terms control if they conflict with specified provisions of the main documents.
Common mistakes
“Side letters are automatically improper preferential treatment.”
No. They are common contractual tools. The legal and economic analysis depends on the provision, disclosure and applicable law.
“The SEC's 2023 side-letter rule is currently in force.”
No. The private-fund rules adopted in 2023 were vacated in 2024.[2]
“A side letter matters only for fees.”
No. Reporting, regulatory, transfer, excuse and governance terms can be equally important.
“Only the recipient needs to care about the side letter.”
Not always. Some terms can affect conflicts, liquidity or economics for other investors.
Example
An investor evaluating Side Letter should read the governing documents and identify the specific convention, rights or obligations that apply rather than relying on the label alone.
Professional note
Side-letter diligence should answer two questions: What special right does this investor receive, and can exercising that right affect the fund or other LPs? That approach distinguishes harmless administrative customization from provisions with genuine economic or governance significance.
Related terms
- Limited Partner (LP)
A limited partner (LP) is an investor or other partner in a limited partnership whose rights, obligations, capital commitment and economic participation are governed by the partnership agreement and applicable law.
- General Partner (GP)
A general partner (GP) is the partner with management authority over a limited partnership, subject to the partnership agreement, applicable law and any duties or restrictions that apply.
- Limited Partnership Agreement (LPA)
A limited partnership agreement (LPA) is the governing contract of a fund organized as a limited partnership, defining the rights, duties, economics, governance rules and operating mechanics of the general partner and limited partners.
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