Side Letter Best Practices for Emerging Managers: What to Grant and What to Avoid

You closed your anchor LP. They loved the pitch. They're wiring the capital. Then their legal team sends over a 12-page side letter and your stomach drops.

Side letters are a normal part of fundraising — but for emerging managers, they're also one of the easiest places to make mistakes that will haunt you for the life of the fund. Over-grant too early, ignore MFN implications, or let institutional LPs dictate non-negotiable terms, and you've created an administrative burden, a legal liability, and a precedent that will compound with every new LP you close.

This guide covers what side letters are, what's standard, what to push back on, and how to build a defensible strategy before your first one lands on your desk.

What Is a Side Letter?

A side letter is a bilateral agreement between a fund manager (the GP) and a specific limited partner that modifies, supplements, or carves out provisions from the fund's Limited Partnership Agreement (LPA) and subscription agreement. It is legally binding and, critically, it exists outside the LPA — meaning most of your other LPs won't see it.

Side letters exist because LPs have different risk profiles, legal obligations, regulatory constraints, and leverage. A $50M sovereign wealth fund has different needs than a $250K family office check. The LPA governs the whole fund; side letters handle the exceptions.

What makes them tricky is the cascade effect. Grant one LP a preferential term, and any LP with a most-favored nation (MFN) clause gets the right to elect the same treatment. Grant enough terms to enough LPs, and you may be running a fund with dozens of overlapping, potentially conflicting side obligations — most of which your fund administrator is now responsible for tracking.

The Standard Provisions (and What They Actually Mean)

1. Fee Discounts and Carry Reductions

The most common side letter provision. Anchor LPs, LPs committing above a certain threshold, or LPs with institutional leverage will often request reduced management fees (e.g., 1.5% instead of 2%) or reduced carry (e.g., 15% instead of 20%).

What's reasonable: Tiered fee structures based on commitment size are defensible and easy to administer. A clean schedule (e.g., commitments over $5M get 1.75%; over $10M get 1.5%) protects you from ad hoc negotiations and sets a clear framework.

What to watch: Never grant carry reductions casually. Carry is your primary economic incentive. An LP asking for 15% carry on a $500K check is asking you to take a pay cut on their behalf. Resist unless they're bringing something beyond capital — deal flow, LP introductions, strategic value.

2. Co-Investment Rights

Co-invest rights give an LP the right — but not the obligation — to invest directly alongside the fund in individual portfolio companies, often at no fee and no carry.

What's reasonable: A right of first offer (ROFO) or notification right for co-invest opportunities is standard for institutional LPs. You notify them, they have a window to decide, and if they pass, you move on.

What to watch: Avoid hard commitments to allocate specific dollar amounts to a single LP. Co-invest rights should always be discretionary on your part. "We will offer you co-invest opportunities as they arise, at our discretion, subject to deal-specific constraints" is the right framing. You cannot guarantee allocation sizes without knowing what your portfolio will look like.

Also: co-invest without fees or carry erodes your economics. Model out what a 20% co-invest LP would cost you in lost management fee income before you agree to blanket no-fee/no-carry co-invest rights.

3. Most-Favored Nation (MFN) Clauses

The MFN clause is the most consequential provision in any side letter. It gives the LP the right to elect any more favorable terms granted to any other LP.

Here's the problem: if you grant LP A a fee discount, and LP B has an MFN, LP B can elect the same discount. If you grant LP C a co-invest right with no carry, LP B can elect that too. And if you have 15 LPs with MFN clauses and you grant any one of them a meaningful concession, you may have just granted it to everyone.

What's reasonable: Institutional LPs will almost always ask for MFN. For large checks, it's hard to deny. But MFN clauses should be scoped and tiered:

• Tiered MFN: LP can only elect terms granted to LPs at the same or lower commitment level. A $1M LP cannot elect terms you gave a $20M LP.
• Excluded provisions: Certain provisions should be carved out of MFN entirely — regulatory carve-outs granted to ERISA LPs, government entity LPs, or non-U.S. investors shouldn't be available to everyone.
• Notice windows: MFN elections should require affirmative notice within a defined window (30–60 days) after disclosure of available terms. Uncapped, open-ended MFN elections are operationally nightmarish.

Emerging manager trap: Many first-time managers grant full, unscoped MFN to their first institutional LP without thinking through the cascade. If you're raising a $20M fund and your $5M anchor gets unrestricted MFN, every subsequent LP you give any side letter term to becomes a potential cost center.

4. Reporting and Information Rights

LPs may request enhanced reporting beyond what the LPA requires — quarterly financial statements, audited annual reports on a specific timeline, portfolio company-level financials, ESG data, or specific data formats compatible with their internal systems.

What's reasonable: Enhanced reporting on a specific schedule is generally fine, especially if the LP is large enough to justify the administrative cost. Quarterly performance reports, capital account statements, and annual audited financials are standard.

What to watch: Be wary of bespoke reporting formats that require manual work outside your fund administrator's standard workflow. If an LP requires custom data extracts, portfolio company financials, or impact metrics that your workflow doesn't support, the cost to deliver that is real — and it's on you.

Also, never commit to reporting timelines you can't control (e.g., "audited financials within 60 days of year-end" when your auditor's standard timeline is 90 days).

5. Advisory Committee Seats (LPAC)

Some LPs request a seat on the Limited Partner Advisory Committee. The LPAC is a governance body that typically approves conflicts of interest, valuation methodology changes, and certain fund-level decisions.

What's reasonable: LPAC seats for your largest LPs (typically top 3–5 by commitment size) are standard. It's a governance best practice, not just an LP demand.

What to watch: LPAC seats create fiduciary obligations. An LP on your LPAC has access to conflict-of-interest information that non-LPAC LPs don't. Be careful granting LPAC seats to smaller LPs who may not understand the role or may be overly activist. Also, LPAC approval requirements can slow down deal execution — keep LPAC scope narrow and well-defined in the LPA.

6. Key Person Modifications

The LPA typically includes a "key person" provision that suspends new investments if a named principal leaves or is incapacitated. LPs may request modifications — adding names, changing thresholds, or adjusting consequences.

What's reasonable: Acknowledging that the fund depends on specific individuals is fair. If you're a solo GP, you are the key person.

What to watch: Avoid side letter provisions that give individual LPs the unilateral right to trigger key person events or expand what constitutes a key person violation. Key person provisions should be uniform across all LPs (i.e., in the LPA, not side letters), with consistent remedies.

7. Transfer Rights

Side letters sometimes grant LPs enhanced transfer rights — the ability to transfer their LP interest to an affiliate, related fund, or successor entity without GP consent.

What's reasonable: Affiliate transfers (e.g., an LP transferring to a sister fund within the same institution) are generally acceptable and commonly requested by institutional LPs.

What to watch: Be explicit about what qualifies as an "affiliate." Broad transfer rights can result in unexpected new LPs who weren't part of your diligence process. Require GP consent for transfers outside clearly defined affiliate categories.

8. Excuse and Exclusion Provisions

Excuse provisions allow an LP to opt out of specific investments — typically for legal, regulatory, or ethical reasons. An ERISA plan, a sovereign wealth fund, or an ESG-mandate LP may request the right to be "excused" from investments in certain geographies, sectors, or company types.

What's reasonable: Regulatory excuse provisions (ERISA, OFAC, sector restrictions imposed by law) are legitimate and expected.

What to watch: Broad discretionary excuse rights (e.g., "we can opt out of any investment we don't like") are operationally disruptive and can create adverse selection problems in your portfolio. Excuse provisions should be narrow and tied to documented legal or regulatory constraints, not LP preference.

Institutional LPs vs. HNW Investors: How the Approach Differs

Institutional LPs — endowments, pension funds, fund of funds, family offices with dedicated alternatives programs — typically arrive with templated side letter requests developed by their legal teams. These are often non-negotiable on certain regulatory provisions (ERISA, FOIA, OFAC) and highly negotiable on economic terms.

High-net-worth individuals and smaller family offices typically have simpler requests: fee discounts, co-invest rights, and reporting preferences. They rarely push for LPAC seats or complex excuse provisions.

Key difference: Institutional LPs have legal obligations that drive their requests. A public pension fund with FOIA exposure genuinely needs confidentiality carve-outs (or the inverse — disclosure rights). An ERISA plan genuinely cannot invest in certain assets. These are compliance requirements, not negotiating tactics.

HNW LP requests are more often preference-driven. That makes them more negotiable but also more important to manage — because HNW LPs are more likely to share terms with each other informally.

ILPA Guidance on Side Letters

The Institutional Limited Partners Association (ILPA) has published guidance on side letter best practices that has become the de facto standard for institutional LP negotiations.

Key ILPA principles:

• Transparency: LPs should receive disclosure of the existence (if not the content) of other LPs' side letters, particularly where MFN rights apply.
• MFN scope: ILPA recommends tiered MFN structures and explicit carve-outs for regulatory provisions.
• Standardization: ILPA encourages GPs to use standardized side letter templates to reduce legal costs and negotiation friction.
• GP-friendly principle: ILPA acknowledges that side letter terms should not materially impair the GP's ability to manage the fund.

For emerging managers, referencing ILPA guidance when pushing back on aggressive side letter requests is a legitimate and credible move. "Our approach is consistent with ILPA best practices" is a phrase that carries weight with institutional counterparts.

Template Structure: What a Side Letter Should Include

A well-drafted side letter typically contains:

1. Parties and recitals — GP, LP, fund name, date, and reference to the LPA and subscription agreement.
2. Defined terms — Incorporating LPA definitions by reference.
3. Specific modifications — Each provision clearly stating what it modifies, supplements, or supersedes.
4. MFN clause (if applicable) — With scope, tiers, carve-outs, and election mechanics.
5. Confidentiality — Typically mutual; LP agrees not to disclose terms to other LPs.
6. Governing law — Consistent with the LPA.
7. Integration clause — The side letter is the entire agreement between the parties on these matters; no oral modifications.
8. Conflict clause — In the event of conflict between the side letter and LPA, the side letter controls (for this LP only).

Keep side letters as short as possible. A side letter that runs more than 8–10 pages for a standard LP is a sign that something is being over-negotiated.

Common Mistakes Emerging Managers Make

Over-Granting Early

Your anchor LP has leverage. You're grateful. You say yes to everything. Three months later, your fourth LP has MFN and elects every term you gave your anchor — including the carry reduction you thought was a one-time exception.

Fix: Know your walk-away terms before you sit down to negotiate. Draft a tiered side letter framework before you start fundraising.

No MFN Strategy

Granting MFN without a tiered structure or carve-out schedule is the single most common and most expensive mistake in side letter management. It turns every future concession into a retroactive concession to every MFN LP.

Fix: Before granting MFN, create an MFN schedule that defines tiers, carve-outs, and election mechanics. Run it by your fund counsel.

Inconsistent Terms Across LPs

Granting inconsistent terms to similarly situated LPs creates LP relations problems and legal exposure. If LP A and LP B are both $2M LPs and LP A gets a fee discount that LP B doesn't know about, you have a problem — especially if LP B later finds out.

Fix: Tiered structures based on objective criteria (commitment size, LP type) eliminate inconsistency.

Committing to Operational Obligations You Can't Fulfill

Promising quarterly portfolio company-level financials when you don't have the systems to produce them, or committing to 45-day audit delivery when your auditor needs 90 days, creates breach scenarios.

Fix: Only commit to obligations you've confirmed with your fund administrator and auditor.

Letting Side Letters Contradict the LPA

A side letter provision that conflicts with the LPA — without an explicit conflict resolution clause — creates legal ambiguity. Courts have generally held that side letters control over LPA provisions for the specific LP, but this should never be left to judicial interpretation.

Fix: Every side letter should have a conflict clause. Your fund counsel should review all side letters against the LPA before execution.

How Side Letters Interact with the LPA and Subscription Agreement

The LPA governs the fund as a whole. The subscription agreement handles LP admission. The side letter modifies both — but only for the specific LP.

Practically, this means:

• Fee calculations must be run separately for LPs with discounts, then aggregated for fund-level reporting.
• Co-invest tracking requires a pipeline system that flags side letter rights for each opportunity.
• MFN elections require a disclosure mechanism — you must notify MFN LPs when new terms are granted.
• Excuse provisions require deal-by-deal tracking of which LPs are excused from which investments and how that affects capital call calculations.

Your fund administrator needs to know about every side letter. Not just their existence — the specific obligations. Budget for the administrative cost of side letter compliance when you're modeling fund economics.

The Bottom Line

Side letters are unavoidable. Institutional LPs won't commit without them. But they're also one of the most controllable variables in your fund setup — if you approach them with a strategy instead of reacting case by case.

Before your first close, build a side letter framework: tiered MFN with carve-outs, a fee schedule, a co-invest policy, and a list of provisions you will and won't grant. Run it by your fund counsel. Then negotiate from that framework instead of from a blank page.

The managers who handle side letters well treat them like a product — standardized, tiered, and consistent. The ones who handle them poorly end up with a different fund for every LP.

That's not a fund. That's a compliance nightmare.

VC Beast covers the operational and legal mechanics of building venture funds — from first close to final distribution. If you're raising your first or second fund, start with our fund formation guide and LP pitch deck breakdown.

“The managers who handle side letters well treat them like a product — standardized, tiered, and consistent.”

— VC Beast