Side Letter
A separate agreement between a fund and one investor that modifies or adds to the standard fund terms just for that investor.
Definition
A side letter is a separate, individually negotiated agreement between a fund (typically the general partner) and a single investor that modifies or supplements the standard terms in the limited partnership agreement just for that investor, without changing the base agreement for anyone else. It is signed alongside the investor's subscription agreement and is typically kept confidential between the fund and that investor.
Side letters commonly cover: reduced management or performance fees for a large or early commitment; enhanced transparency or reporting rights beyond the standard LP reporting cadence; capacity rights guaranteeing access to a future closing or capacity-constrained strategy; and a most-favored-nation (MFN) clause, which gives that investor the right to elect specified categories of more favorable terms (commonly fees, reporting, or liquidity rights) the fund later grants to a similarly-situated investor — typically with carve-outs for terms tied to commitment size or timing.
Because a side letter can only bind the fund and the specific investor who signed it, it does not amend the LPA itself — it sits alongside it as an investor-specific carve-out, and if the two documents conflict for that investor, the side letter's more specific terms typically control.
Why it matters
Side letters let a fund accommodate large or strategically important investors — anchor commitments, seed investors, or institutional LPs with their own regulatory requirements — without renegotiating the LPA for the entire investor base every time.
The MFN clause is the mechanism that keeps side letters from becoming a source of unfair treatment: it gives investors who negotiated one a defined right to match better terms granted later, rather than leaving early or smaller investors permanently disadvantaged relative to whoever negotiates hardest.
How side letters get negotiated and applied
A side letter is typically negotiated during the subscription process, executed at the same time as the subscription agreement, and referenced (without necessarily disclosing its specific terms) in the fund's investor records so the administrator applies the correct fee rate, reporting cadence, or other term to that investor's account going forward.
An investor with an MFN clause is typically notified when the fund grants a more favorable term to another investor of the same class, and given a window to elect whether to take that term for themselves — accepting one MFN-eligible term does not usually require accepting all of them, since funds commonly let the investor pick which specific provisions to adopt.
Common mistakes
Assuming an MFN clause automatically grants every better term to every MFN holder the moment it is signed — in practice, MFN rights are usually elective and require the investor to actively choose to adopt a specific term, not an automatic blanket upgrade.
Treating side letters as fully public documents — they are typically confidential between the fund and the specific investor, which is precisely why an MFN clause exists: to give other investors a mechanism to access equivalent terms without the fund having to disclose every letter to everyone.
Losing track of which side letter terms are still in effect as investors redeem and re-subscribe over time — a side letter tied to a specific commitment size can lapse if that investor's position changes, and administrators need this reconciled against current fee and reporting logic.
Believing a side letter can grant an investor a right that contradicts the fund's actual regulatory or tax filings — a side letter can adjust economics and reporting between the fund and one investor, but it operates within the constraints already set by the fund's structure, not outside them.
In practice
Crypto funds commonly use side letters for the same reasons traditional funds do — fee breaks for anchor capital, enhanced reporting for institutional LPs conducting ongoing diligence — but crypto-specific side letters also appear around token-specific exclusions (an investor with a compliance restriction on a particular asset opting out of exposure to it) and bespoke liquidity terms for investors uncomfortable with a fund's standard lock-up period given crypto market volatility.
Because side-letter fee terms and standard LPA fee terms need to be applied correctly per investor at every fee run, funds typically track each investor's actual negotiated terms carefully rather than relying on memory — getting a side-letter fee reduction wrong shows up directly as an incorrect number on that investor's next statement.
Questions, answered
What is a side letter in a hedge fund context?
A side letter is a separate agreement between a fund and one specific investor that modifies or adds to the standard partnership agreement terms just for that investor — for example, a reduced fee, enhanced reporting, or a most-favored-nation clause.
What is a most-favored-nation (MFN) clause?
An MFN clause gives an investor with a side letter the right to elect any more favorable term the fund later grants to another similarly-situated investor. It is typically elective — the investor chooses which specific terms to adopt, rather than receiving every better term automatically.
Are side letters public documents?
No, they are typically kept confidential between the fund and the specific investor who negotiated them. The MFN clause exists partly because side letters are not broadly disclosed to every investor.
Can a side letter override the limited partnership agreement?
A side letter does not amend the limited partnership agreement itself. It sits alongside it as an investor-specific carve-out, and where the two conflict for that one investor, the more specific side-letter terms typically control — but only for that investor.
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