What is a side letter in venture capital?

A side letter is a supplemental legal agreement between a fund's general partner and one or more specific limited partners that modifies the standard LP agreement terms for those particular investors. Side letters are private — other LPs generally don't know about them — and they survive as binding agreements alongside the main fund documents.

Common provisions in VC side letters include: reduced management fees or carried interest (often granted to large anchor investors or early commitments); most-favored-nation (MFN) clauses, where the LP is guaranteed to receive the best terms offered to any other LP; co-investment rights, giving the LP the right to invest alongside the fund in specific deals; enhanced reporting, like quarterly rather than annual LP reports; and specific exclusions, where an LP (such as a public pension fund) excludes certain types of investments for regulatory reasons.

Side letters have become extremely common — some large funds have a side letter with nearly every LP. This creates significant complexity in fund administration, since the GP must track each LP's unique terms and ensure compliance across potentially dozens of bespoke agreements.

The most favored nation (MFN) clause is particularly interesting. If an LP has an MFN provision and the GP grants a more favorable fee structure to a new LP, the MFN holder is automatically entitled to those same better terms. This creates interesting dynamics when GPs try to attract large new investors with sweetened terms — they may be simultaneously improving terms for all MFN holders.

From an LP perspective, a side letter is a negotiating opportunity. An institutional LP anchoring a first-time fund at $20M of a $50M target has significant leverage to ask for co-investment rights, fee reductions, and enhanced governance. Understanding what side letter rights are available and how to negotiate them is a core LP skill.