VentureKit
Side Letters in Venture Capital: What LPs Ask For and When to Grant It
Almost every institutional fundraise ends with at least one LP asking for terms the LPA does not give them. Those asks land in side letters — and how a first-time GP handles them determines whether the fund closes with a clean, manageable set of obligations or a tangle of conflicting promises that compounds through the MFN cascade. Founders meet the same concept from the other side: the MFN clause baked into one version of the post-money SAFE. This guide covers both.
Written by Michael Kaufman · Reviewed against our editorial standards · Updated
Sources & further reading: ILPA templates, standards & model documents, NVCA model legal documents, and Y Combinator SAFE financing documents.
Quick Answer
A side letter is a private contract between a fund's general partner and an individual limited partner that modifies or supplements the Limited Partnership Agreement for that LP only. LPs use side letters to secure most-favored-nation (MFN) protection, management fee or carry discounts, co-investment rights, enhanced reporting, excuse rights tied to their regulatory status, and advisory committee seats. Founders encounter the same concept in early-stage fundraising: Y Combinator's post-money SAFE ships with an optional pro rata side letter, and one of its three US versions is an uncapped SAFE whose MFN clause lets the holder adopt better terms the company later gives other convertible investors. For emerging GPs, the core discipline is knowing which asks are cheap to grant (standardized reporting, legally required excuse rights), which are expensive (untiered MFN, fee breaks that cascade to every MFN holder), and which to refuse (guaranteed allocations, vetoes over investment decisions).
Key Takeaways
- 1.A side letter binds the GP to one LP only — it supplements the LPA rather than amending it for everyone, and most modern LPAs expressly authorize the GP to sign them.
- 2.The five most common LP asks are MFN clauses, fee or carry discounts, co-investment rights, enhanced reporting, and excuse rights tied to the LP's legal or policy constraints.
- 3.MFN clauses cascade: an untiered MFN lets every holder elect the single best concession you granted anyone, so always tier MFN by commitment size and carve out regulatory provisions.
- 4.Grant cheaply what costs you nothing (ILPA-aligned reporting, legally required excuse rights); negotiate what has a price (fee breaks, co-invest); refuse what breaks the blind pool (investment vetoes, guaranteed allocations).
- 5.Founders see MFN in a different wrapper — YC's uncapped MFN safe upgrades to any better convertible terms issued later, so check outstanding MFN safes before issuing a lower-cap instrument.
- 6.Every side letter obligation survives for the life of the fund. Track them in a compendium from day one, because a forgotten reporting covenant is still a breach in year eight.
What Is a Side Letter?
A side letter is a separate, private agreement between the fund’s General Partner and a single Limited Partner, executed alongside that LP’s subscription agreement. Where the Limited Partnership Agreement sets one uniform rulebook for every investor in the fund, the side letter carves out exceptions and additions for one investor: a fee discount here, a reporting covenant there, an excuse right driven by that LP’s regulatory position.
Side letters exist because LPs are not uniform. A public pension operates under open-records laws, an ERISA plan has fiduciary constraints, a sovereign investor may need immunity preserved, and a fund-of-funds has its own investors’ reporting expectations to satisfy. Negotiating leverage also differs: the anchor writing a quarter of the fund reasonably expects economics the last $250K check does not get. Rather than renegotiating the LPA for each investor, the market resolves both problems through side letters — and most modern LPAs expressly authorize the GP to enter into them without other LPs’ consent.
Two reference points anchor the drafting norms. On the fund side, the Institutional Limited Partners Association publishes the templates and model documents — including a Model LPA, Model Subscription Agreement, and the ILPA Reporting Template — that institutional LPs treat as the baseline for what they should be able to get. On the deal side, the NVCA model legal documents play the same standardizing role for the venture financings the fund will go on to make.
What LPs Ask For in Side Letters
Nearly every institutional side letter draws from the same menu of provisions. Understanding what each ask really costs you — and why the LP wants it — is the difference between a clean negotiation and an expensive one.
Most-Favored-Nation (MFN) Clauses
The MFN clause is usually the first institutional ask. It gives the LP the right to elect the benefit of any more favorable term the GP grants to another investor in the same fund. The LP is not negotiating a specific concession — they are insuring against being the investor who negotiated worst.
MFN clauses are rarely refused outright, but they are almost never granted flat. Market practice is to tier the MFN by commitment size (the LP may only elect terms granted to investors with equal or smaller commitments) and to carve out provisions driven by another LP’s specific legal, tax, or regulatory status. The mechanics of the election — and how an untiered MFN cascades — are covered in the next section.
Management Fee and Carry Discounts
Fee breaks are the most economically direct ask: a reduced management fee rate, a fee holiday for first-close investors, or occasionally reduced carried interest. LPs justify them by size (a large commitment lowers your fundraising cost), by timing (first-close capital de-risks the raise), or by relationship (an anchor who will also help with references and future closes).
The trap for emerging managers is pricing a discount against a single check while every MFN holder in the book can elect it. A fee break is never just that LP’s fee break unless your MFN tiering makes it so. Price concessions against the fully elected cost, not the single-LP cost.
Co-Investment Rights
Larger LPs and family offices frequently ask for the right to co-invest alongside the fund, usually on a no-fee, no-carry basis. For the LP, co-invest blends down their effective fee load and concentrates exposure in deals they like. For the GP, it can be a genuine relationship asset — co-invest capital helps you win larger allocations than your fund could take alone.
The negotiation point is the strength of the promise. Offering to consider the LP for co-investment opportunities, or to use commercially reasonable efforts to show them deals, is grantable. Guaranteeing a fixed allocation in every deal is not — it constrains deals you have not sourced yet and creates conflicts with other co-invest holders when allocations are tight.
Enhanced Reporting and Transparency
Institutional LPs — particularly pensions, endowments, and funds-of-funds — often ask for reporting beyond the LPA’s baseline: quarterly reporting aligned with the ILPA Reporting Template, fee and expense breakdowns, portfolio company detail, and prompt notice of key person events, regulatory proceedings, or LPA amendments.
These asks are usually cheap to grant if — and only if — you standardize. Committing to one ILPA-aligned reporting package for everyone costs far less than maintaining five bespoke report formats for five LPs. The expensive version of this ask is custom: an LP-specific data feed or a nonstandard valuation cadence multiplies work every quarter for a decade.
Excuse Rights and Regulatory Provisions
Excuse rights let an LP sit out a specific investment that would violate a law, regulation, or written policy binding on them — an ERISA plan avoiding a prohibited transaction, a public pension bound by state statute, a mission-constrained endowment screening out specific sectors, or a non-US investor with home-country restrictions. Related provisions address confidentiality carve-outs for LPs subject to public records laws and preservation of sovereign immunity.
These are the easiest grants in the book when drafted narrowly: they reflect who the LP legally is, not negotiating appetite. Keep them tied to written policies that exist at closing, and carve them out of your MFN — a taxable family office should not be able to elect an ERISA plan’s excuse right as a discretionary opt-out.
Governance Extras: LPAC Seats, Notices, Transfers
The remaining common asks are governance-flavored: a seat (or observer seat) on the LP Advisory Committee, advance notice of amendments or GP changes, consent mechanics for transfers to the LP’s own affiliates, and acknowledgment of the LP’s placement-agent or pay-to-play compliance requirements. LPAC seats deserve real thought — the committee handles conflicts and valuation questions, and packing it via side letters dilutes its function. Grant seats sparingly and cap the committee’s size in the LPA itself.
Common Side Letter Asks at a Glance
A working map of who asks for what, and the posture an emerging manager should start from. None of this is legal advice — it is the shape of the negotiation, not a substitute for fund formation counsel.
| Provision | Who typically asks | Typical GP posture |
|---|---|---|
| MFN clause | Institutions, funds-of-funds | Grant — but tiered by commitment size, with regulatory carve-outs |
| Fee / carry discount | Anchors, first-close and large LPs | Negotiate — tie to size and timing, price against the MFN cascade |
| Co-invest rights | Family offices, larger institutions | Grant as best-efforts offers; refuse guaranteed allocations |
| ILPA-aligned reporting | Pensions, endowments, funds-of-funds | Grant — standardize one package for all LPs rather than bespoke formats |
| Excuse / exclusion rights | ERISA plans, public pensions, sovereigns, policy-constrained LPs | Grant narrowly — tied to written legal or policy constraints, carved out of MFN |
| LPAC seat | Largest LPs | Grant sparingly; cap committee size in the LPA |
| Investment vetoes / opt-outs at will | Occasionally, inexperienced or strategic LPs | Refuse — discretionary opt-outs break the blind pool for everyone |
Archstone
Run your fund like an institution.
MFN Cascade Mechanics: How One Concession Spreads
The MFN election usually works like this. At or shortly after final close, fund counsel assembles a compendium of all side letter provisions across the fund, typically organized by provision type with granting LPs anonymized. Each MFN holder receives the compendium — or the portion they are entitled to see under their tier — and has a defined window to elect the provisions they want. Elected provisions then bind the GP as if they had been in that LP’s own side letter from the start.
Three drafting levers control how far a concession spreads. First, tiering: limiting elections to terms granted to LPs with equal or smaller commitments, so a $1M investor cannot claim the $10M anchor’s economics. Second, carve-outs: excluding provisions driven by another LP’s legal, tax, or regulatory status, and often excluding specifically negotiated anchor arrangements. Third, scope: whether the MFN covers only this fund or reaches parallel vehicles and successor funds — the latter is a much bigger promise and a common overreach in first-fund negotiations.
Worked Hypothetical: The Untiered MFN
Illustrative numbers only — not market data. A GP closes a $30M Fund I with a 2% management fee. The $6M anchor negotiates a 25 basis point fee discount (an effective 1.75% rate on their commitment). Three later LPs — $3M, $2M, and $1M — each negotiate MFN clauses with no size threshold.
At final close, counsel circulates the compendium and all three MFN holders elect the anchor’s discount. The concession now applies to $12M of commitments instead of $6M: forgone fees double from $15,000 per year (25 bps on $6M) to $30,000 per year — roughly $150,000 across a five-year investment period at that rate, for a discount the GP priced against a single anchor check.
Had the MFN been tiered at commitments of $6M or more, none of the three smaller LPs could have elected it, and the concession would have cost exactly what it was priced to cost. Tiering is the single highest-leverage clause in MFN drafting.
The cascade also runs on non-economic terms. An enhanced reporting covenant, a co-invest offer obligation, or a transfer consent standard elected by several MFN holders multiplies your operational surface area the same way a fee break multiplies its cost. This is why experienced fund counsel prices every side letter grant with the question: what does this cost if everyone who can elect it does?
What Founders See: Side Letters and MFN in SAFEs
Founders rarely deal with fund-style side letters, but the same two instruments show up in early-stage rounds under the same names. Y Combinator’s SAFE financing documents — the standard for early-stage convertible fundraising since YC introduced the safe in late 2013 — include three US post-money versions plus an optional side letter: a valuation cap version, a discount version, and an uncapped MFN version, alongside the pro rata side letter.
The pro rata side letter is the founder-side equivalent of a fund LP’s co-invest right: a separate one-page agreement giving the SAFE investor the right to purchase their pro rata share in the next priced round. It is optional and negotiated investor by investor — which is exactly the point of a side letter: the base instrument stays standard while individual investors get individually negotiated extras.
The uncapped MFN safe is the founder-side MFN cascade. The investor accepts no valuation cap and no discount today, in exchange for the right to adopt the terms of any more favorable safe or convertible instrument the company issues later, before their safe converts or terminates. Issue a $10M-cap safe six months after taking uncapped MFN money and the MFN holders are entitled to upgrade to the $10M cap. The discipline mirrors the GP side: before granting better terms to a new investor, check what existing MFN obligations those terms will trigger.
Founders should also expect side-letter-style asks beyond YC’s standard forms — information rights, board observer seats, or expense reimbursement requested in a separate letter alongside a SAFE. The evaluation framework from the fund world transfers directly: grant what reflects the investor’s legitimate needs cheaply, negotiate what has a real price, and never grant a term you cannot track. For how these instruments fit into a priced round later, see our term sheet guide.
When to Grant, When to Negotiate, When to Refuse
A practical triage for emerging managers staring at a side letter markup the week before close.
Grant Readily
Provisions that reflect who the LP legally is, and provisions you can satisfy once for everyone: narrowly drafted excuse rights tied to written laws or policies, confidentiality carve-outs for public-records LPs, ILPA-aligned reporting you will produce anyway, notice of key person events and material amendments, and affiliate-transfer consent with a reasonable GP-consent standard. Refusing these signals inexperience without saving you anything.
Negotiate on Price and Structure
Provisions with a real cost that can still be worth paying: fee and carry discounts (tie them explicitly to commitment size and first-close timing so the rationale is defensible and MFN-tierable), co-invest rights (offer consideration or best efforts, never guaranteed allocations), MFN clauses (tier by size, carve out regulatory provisions, limit scope to this fund), and LPAC seats (cap the committee). The negotiation is not whether to grant — it is how to bound what you grant.
Refuse
Provisions that break the fund for everyone else: discretionary opt-outs from investments (an excuse right without a legal basis is just a veto), consent rights over individual investment decisions, guaranteed co-invest allocations, untiered MFN in a fund with mixed check sizes, MFN reaching your successor funds, and any obligation your one-person back office cannot reliably track for ten years. A blind pool with per-LP vetoes is not a blind pool — and sophisticated LPs know that a GP who grants these terms to one investor has devalued the fund they are buying into.
Operationalizing Side Letters After the Close
Side letter obligations do not expire when the fundraise ends — they run for the life of the fund. The standard practice is a side letter compendium: a single tracked document (or fund-administration workflow) listing every obligation, who it is owed to, its trigger, and its cadence. Build it during the raise, not after; the GP who discovers a forgotten quarterly reporting covenant in year three is already in breach.
The cleanest prevention is a standard menu: decide before the raise which provisions you will offer at which commitment levels, and negotiate from that menu instead of improvising LP by LP. It shortens negotiations, keeps the MFN compendium boring, and signals institutional discipline to exactly the LPs who care. For where side letters fit in the full sequencing of a raise, see the LP fundraising playbook and the full VC fund documents stack.
Legal Disclaimer
This guide is provided for educational and informational purposes only and does not constitute legal, tax, or investment advice. Side letter terms, MFN mechanics, and market practice vary by jurisdiction, fund strategy, LP base, and individual negotiation. The numeric example on this page is a clearly labeled hypothetical, not market data. Always engage qualified fund formation counsel before drafting, negotiating, or executing side letters or any other fund documents.
Archstone
Run your fund like an institution.
Frequently Asked Questions
What is a side letter in venture capital?
A side letter is a private, legally binding agreement between a fund's general partner and an individual limited partner that supplements or modifies the terms of the Limited Partnership Agreement for that LP only. Most modern LPAs expressly authorize the GP to enter into side letters without the consent of other investors. LPs use them to secure terms that reflect their specific regulatory status, negotiating leverage, or commitment size — most-favored-nation protection, fee discounts, co-investment rights, enhanced reporting, and excuse rights are the most common asks.
What is an MFN clause in a side letter?
A most-favored-nation (MFN) clause gives an LP the right to elect the benefit of any more favorable term the GP grants to another LP in the same fund. In practice, MFN clauses are almost always tiered by commitment size — an LP can only elect terms granted to investors with equal or smaller commitments — and carve out provisions tied to another LP's specific legal, tax, or regulatory status. The election typically happens after final close, when fund counsel circulates a compendium of side letter provisions and each MFN holder chooses which eligible terms to adopt.
Do side letters override the LPA?
As between the GP and the LP that signed it, yes — to the extent the LPA authorizes side letters, which most modern fund agreements expressly do. The side letter modifies or supplements the LPA's terms for that investor alone. That said, side letter provisions that conflict with the LPA's core mechanics or that would disadvantage other LPs invite challenge, which is why fund formation counsel drafts them narrowly and why certain terms (like changes to the waterfall itself) belong in the LPA, not a side letter.
Do other LPs get to see side letters?
Not by default. Side letters are private agreements, and most LPs never see the letters other investors signed. MFN holders are the exception: to exercise an MFN election, they receive a compendium summarizing the side letter provisions eligible for election, often with the granting LP's identity anonymized. Some large institutions negotiate broader disclosure rights, and public pension LPs may themselves be subject to public records laws that can expose their own side letter terms.
What does the MFN clause in a SAFE mean for founders?
Y Combinator's post-money SAFE comes in three US versions, one of which is the uncapped MFN safe — no valuation cap and no discount, but with a most-favored-nation provision. The investor accepts uncapped terms today in exchange for the right to adopt the terms of any more favorable safe or convertible instrument the company issues later, before their safe converts or terminates. For founders, the practical rule is to track outstanding MFN safes before issuing a lower-cap or discounted instrument, because doing so upgrades every MFN holder to those better terms.