TL;DR: A side letter is the contract behind the contract - a separate agreement that modifies, supplements, or clarifies terms of a main agreement without formally amending it. Side letters are used when one party needs a concession, exception, or additional right that the other parties to the main agreement should not or need not see. They are everywhere in fund formation (LP side letters granting preferential economics, co-investment rights, or regulatory accommodations), commercial transactions (pricing adjustments, warranty extensions, service level modifications), and corporate deals (management arrangements, earnout clarifications, executive compensation). The power and the danger of side letters lie in the same characteristic: they exist outside the four corners of the main agreement. This creates tension with entire agreement clauses, raises confidentiality issues (can the main agreement parties discover the side letter's existence?), and generates most-favored-nation (MFN) complications when multiple side letters create a patchwork of different rights for different parties. In fund formation, the SEC and ILPA have pushed hard for transparency around side letter terms, and the SEC's 2023 Private Fund Adviser Rules introduced new disclosure and fairness requirements that have fundamentally changed side letter practice.

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What Is a Side Letter?

A side letter is a written agreement, executed separately from and typically contemporaneously with a main agreement, that modifies, supplements, clarifies, or creates exceptions to the terms of the main agreement for one or more specific parties. Unlike a formal amendment (which modifies the main agreement itself and typically requires consent of all parties), a side letter operates as a standalone contract between the side letter parties, leaving the main agreement unchanged on its face.

Side letters serve several distinct purposes. First, they provide confidential accommodations: a limited partner in a fund may negotiate fee reductions, co-investment rights, or transfer restrictions that the general partner does not want disclosed to other investors. Second, they address party-specific regulatory requirements: a government pension plan investing in a fund may require transparency provisions, FOIA carve-outs, or investment restriction compliance that do not apply to other investors. Third, they resolve last-minute negotiation points without reopening the main agreement: when the principal terms are agreed but one party needs a specific concession, a side letter avoids the delay and complexity of amending a multi-party document.

The legal nature of a side letter is that of a binding contract. It must satisfy the same formation requirements as any other agreement: offer, acceptance, consideration, and (where required) writing. The side letter typically references the main agreement explicitly, states that it modifies or supplements specific provisions, and includes its own governing law, dispute resolution, and termination provisions. In the event of conflict between the side letter and the main agreement, the side letter should contain an express priority provision stating which document prevails.

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Why It Matters

Negotiation Efficiency: Side letters allow parties to close a transaction on the main agreement's standard terms while addressing party-specific requests separately. This avoids holding up a multi-party signing for bilateral negotiations and keeps the main document clean for all parties.
Confidentiality of Commercial Terms: Side letters enable parties to keep sensitive accommodations (pricing concessions, warranty extensions, equity arrangements) confidential from other counterparties. In fund formation, this is particularly valuable where different investors negotiate different economic terms.
Regulatory Accommodation: Government entities, pension funds, sovereign wealth funds, and regulated financial institutions have legal and policy constraints that require modifications to standard fund terms. Side letters address these requirements without imposing them on the entire investor base.
Risk of Hidden Obligations: The existence of undisclosed side letters can create material risks for parties who are not aware of them. A buyer in an M&A transaction who acquires a company without knowledge of side letters modifying key contracts may find that the acquired contracts are materially different from what was represented in due diligence.
MFN Complexity: When multiple investors receive side letters with different terms, most-favored-nation provisions create a web of cross-referencing rights. Managing MFN elections across dozens of side letters is a significant administrative and legal burden, and errors can result in unintended obligations.

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Key Elements of a Well-Drafted Side Letter

Reference to Main Agreement: Identify the main agreement by its full title, date, and parties. State that the side letter supplements and, to the extent of any conflict, supersedes the specified provisions of the main agreement. Without a clear reference, the side letter may be interpreted as a standalone agreement without connection to the main document.
Specific Modifications: Identify each provision of the main agreement being modified, supplemented, or clarified by section number. State the modification with precision - do not merely reference "more favorable terms" or "enhanced rights" without specifying the exact change. For each modification, state whether it replaces, supplements, or creates an exception to the main agreement provision.
Priority and Conflict Resolution: Include an express provision stating that in the event of any conflict or inconsistency between the side letter and the main agreement, the side letter prevails. Without this language, courts may apply general rules of contract interpretation that could subordinate the side letter to the main agreement, particularly if the main agreement contains a strong entire agreement clause.
Confidentiality: Address whether the existence and terms of the side letter are confidential. Specify who may receive copies of the side letter (legal counsel, auditors, regulators) and the consequences of unauthorized disclosure. In fund formation, address how the side letter interacts with MFN disclosure obligations.
MFN Provisions: If the side letter grants preferential terms, address whether the recipient is entitled to elect terms from other side letters (MFN-in) and whether the terms of this side letter may be elected by other investors exercising MFN rights (MFN-out). Specify any carve-outs from MFN eligibility (regulatory accommodations, capacity-based co-investment rights, fee terms based on commitment size).
Term and Termination: Specify whether the side letter terminates when the main agreement terminates, survives termination of the main agreement, or has its own independent term. Address what happens to side letter rights if the main agreement is amended - does the side letter automatically adjust, or does it require separate amendment?
Entire Agreement Integration: Address the interaction with any entire agreement (integration) clause in the main agreement. The entire agreement clause in the main agreement may state that the main agreement represents the complete agreement between the parties and supersedes all prior agreements. The side letter should expressly state that it is an exception to or supplement to the entire agreement clause, or that the parties agree the entire agreement clause does not apply to the side letter.

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Market Position & Benchmarks

Where Does Your Clause Fall?

Side Letter Recipient-Favorable: Broad modifications to economics (management fee reduction, carry discount), full co-investment rights on all deals, portfolio-level transparency exceeding standard reporting, transfer rights beyond those in the LPA, key person provisions tailored to the LP's requirements, MFN with no carve-outs, side letter survives termination of the main agreement.
Balanced / Market Standard: Targeted modifications addressing regulatory requirements and specific commercial asks, co-investment rights on a best-efforts or allocation-proportional basis, enhanced reporting for large investors, MFN with standard carve-outs for regulatory and size-based terms, side letter terminates with the main agreement, confidentiality subject to regulatory disclosure.
Side Letter Grantor-Favorable: Narrow modifications limited to regulatory requirements only, no economic concessions beyond commitment-size-based fee breaks already in the LPA, co-investment at GP's sole discretion, MFN with broad carve-outs, side letter may be terminated by the grantor on 90 days' notice, full confidentiality with narrow disclosure exceptions.

Market Data

According to ILPA surveys, over 90% of institutional LPs in private equity funds negotiate side letters, with the average fund having 15-30 side letters across its investor base.
The most commonly negotiated side letter provisions (per Investec and Preqin surveys) are: co-investment rights (present in approximately 70% of LP side letters), MFN elections (65%), enhanced reporting and transparency (60%), fee and carry modifications (55%), and transfer rights (40%).
The SEC's 2023 Private Fund Adviser Rules (adopted August 2023) introduced a requirement for advisers to distribute an annual summary of material side letter terms to all investors, fundamentally changing the confidentiality dynamic. The legacy activity exception and other compliance details remain subject to industry guidance.
In commercial transactions, side letters are used less systematically but are common in franchise relationships (territory modifications, fee adjustments), supply agreements (pricing carve-outs, volume commitments), and joint ventures (management fee arrangements, profit allocation modifications).
MFN elections typically result in 30-50% of eligible LPs electing at least one provision from another investor's side letter, with co-investment rights and fee reductions being the most frequently elected terms.

Sample Language by Position

LP-Favorable (Fund Formation): "Notwithstanding anything to the contrary in the Partnership Agreement, the General Partner agrees that: (a) the Management Fee payable by the Limited Partner shall be reduced by [25] basis points from the rate set forth in Section 6.1 of the Partnership Agreement; (b) the Limited Partner shall have a co-investment right to participate in each Portfolio Investment on a pro rata basis (based on the Limited Partner's Commitment relative to total Commitments), which right shall be offered to the Limited Partner prior to or concurrently with any offer to co-invest made to any other Person; and (c) the General Partner shall provide the Limited Partner with quarterly portfolio company-level financial statements within forty-five (45) days of each quarter end."

Balanced: "This Side Letter is entered into between the General Partner and the Limited Partner in connection with and as a supplement to the Partnership Agreement. In the event of any conflict between this Side Letter and the Partnership Agreement, the terms of this Side Letter shall prevail, but only as between the General Partner and the Limited Partner, and only to the extent of such conflict. This Side Letter shall not modify the rights or obligations of any other Partner under the Partnership Agreement. The existence and terms of this Side Letter shall be treated as Confidential Information under Section 14 of the Partnership Agreement, subject to disclosure as required by law, regulation, or judicial process, and subject to disclosure in connection with the MFN process described in Section 4 below."

GP-Favorable (Fund Formation): "The modifications set forth herein are granted solely to accommodate the regulatory requirements applicable to the Limited Partner in its capacity as a [state pension fund / sovereign wealth fund / regulated insurance company] and do not constitute economic concessions. These modifications shall not be subject to the Most Favored Nation provisions of the Partnership Agreement and shall not be available for election by any other Limited Partner. The General Partner reserves the right to terminate this Side Letter upon ninety (90) days' written notice if the General Partner determines, in its reasonable discretion, that the continued application of these modifications would be materially prejudicial to the Partnership or the other Limited Partners."

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Example Clause Language

Fund Formation - MFN Provision: "Most Favored Nation. The General Partner shall, within thirty (30) days following the final closing of the Partnership, deliver to the Limited Partner copies of all side letters entered into with other Limited Partners (with the identity of such Limited Partners redacted unless such Limited Partners have consented to disclosure). The Limited Partner may, within thirty (30) days of receipt, elect to receive the benefit of any provision contained in such other side letters, provided that: (i) provisions granted solely to accommodate regulatory requirements specific to the applicable Limited Partner shall not be eligible for election; (ii) provisions based on a Commitment size exceeding the Limited Partner's Commitment shall not be eligible for election; and (iii) co-investment allocation provisions based on capacity or investment program criteria specific to the applicable Limited Partner shall not be eligible for election."

Commercial Agreement - Pricing Side Letter: "This Side Letter supplements the Master Supply Agreement dated [Date] between Supplier and Buyer (the 'MSA'). Notwithstanding the pricing set forth in Exhibit A to the MSA, the Parties agree that, for the period commencing on the Effective Date and ending on December 31, [Year] (the 'Promotional Period'), the per-unit price for Products ordered by Buyer shall be reduced by fifteen percent (15%) from the prices set forth in Exhibit A. Upon expiration of the Promotional Period, standard MSA pricing shall apply to all subsequent orders without further action by either Party. This Side Letter is confidential and shall not be disclosed to any third party without the prior written consent of both Parties."

M&A - Earnout Clarification Side Letter: "This Side Letter is entered into between Buyer and Seller Representative in connection with the Stock Purchase Agreement dated [Date] (the 'SPA'). The Parties agree that, for purposes of calculating EBITDA under Section 2.6 of the SPA, the following adjustments shall apply: (a) revenue from the [Project X] contract shall be included in the EBITDA calculation notwithstanding the classification of such revenue as 'non-recurring' under GAAP; (b) the costs of integration activities directed by Buyer shall be excluded from operating expenses; and (c) corporate overhead allocated by Buyer to the Business following Closing shall not exceed $[amount] per quarter without the Seller Representative's consent for purposes of the earnout calculation only."

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Common Contract Types

Limited Partnership Agreements (Fund Formation): The most systematic use of side letters. Virtually every institutional LP in a PE, VC, real estate, or hedge fund negotiates a side letter covering economics, governance, reporting, co-investment, transfer, and regulatory accommodations.
Supply and Distribution Agreements: Side letters modify pricing, volume commitments, exclusivity scope, or territory allocations for specific customers or distributors without amending the master agreement that governs the broader relationship.
Franchise Agreements: Franchisors issue side letters granting territory protections, fee modifications, or operational exceptions to specific franchisees without modifying the standard form franchise agreement filed with state regulators.
M&A Agreements: Side letters clarify earnout calculation methodologies, management compensation arrangements, transition service commitments, or other terms that the parties prefer to keep separate from the publicly filed deal agreement.
Employment and Executive Compensation: Side letters supplement offer letters or employment agreements with additional equity grants, retention bonuses, severance enhancements, or role modifications without formal amendment of the underlying employment contract.
Joint Venture Agreements: JV partners use side letters to address management fee arrangements, secondment terms, profit allocation modifications, or exit mechanics that apply to specific partners without modifying the JV agreement itself.
Loan and Credit Agreements: Borrowers and lenders use side letters to document covenant waivers, reporting modifications, or fee arrangements that supplement the credit agreement without requiring a formal amendment (which may require lender consent thresholds).

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Negotiation Playbook

Key Drafting Notes

Address the entire agreement clause head-on: If the main agreement contains an entire agreement (integration) clause, the side letter must expressly state that it constitutes an exception to or modification of that clause. Without this language, a court may hold that the entire agreement clause renders the side letter unenforceable as an extrinsic agreement inconsistent with the integrated contract. The safest approach is to include carve-out language in both the main agreement and the side letter.
Be precise about MFN mechanics: Specify the MFN election process (timeline, delivery, format), the categories of provisions excluded from MFN (regulatory, size-based, capacity-based), whether MFN elections are "all or nothing" for a given side letter or may be cherry-picked provision by provision, and how MFN elections interact with the electing LP's own side letter (do elected provisions replace or supplement existing terms?).
Coordinate side letters across fund series: If a GP operates multiple fund vintages, LPs often expect side letter terms to carry over from prior funds. Address this expectation explicitly: does the side letter apply only to the current fund, or does it establish a precedent for successor funds? GPs generally resist automatic carry-over; LPs push for it.
Include a no-prejudice clause for other parties: State that the side letter does not modify the rights or obligations of any party to the main agreement other than the side letter parties. This protects against arguments by third parties that the side letter has altered their position under the main agreement.
Address regulatory disclosure requirements: Following the SEC's 2023 Private Fund Adviser Rules, GPs must distribute annual summaries of material side letter terms. Draft side letter confidentiality provisions to accommodate this requirement. Also address FOIA obligations of government LP investors, regulatory examination requirements, and legal or judicial process disclosure.

Common Pitfalls

Failing to address the entire agreement clause: This is the most common drafting failure. If the main agreement says it constitutes the "entire agreement" and supersedes all other agreements, and the side letter does not expressly address this, the side letter may be unenforceable under the parol evidence rule or the integration doctrine.
Inconsistent MFN treatment across side letters: If different side letters contain different MFN carve-out categories, or if some side letters are subject to MFN and others are not, the resulting patchwork can create unintended obligations and administrative chaos. Standardize MFN provisions across all side letters in a fund.
No process for managing MFN elections: MFN elections require distributing redacted side letters, tracking election deadlines, confirming elected provisions, and updating fund records. Without a defined process and dedicated resources, MFN administration becomes a compliance risk.
Undisclosed side letters in M&A due diligence: A target company that has entered into side letters modifying customer contracts, supplier agreements, or employee arrangements may fail to disclose these in due diligence. The buyer acquires the company and discovers that the actual contractual terms differ materially from the main agreements reviewed. Always ask specifically about side letters, amendments, and supplemental agreements during due diligence.
Side letters that contradict fiduciary duties: In fund formation, a side letter that grants one LP preferential economics, information rights, or exit rights at the expense of other LPs may conflict with the GP's fiduciary duties to all partners. The SEC's 2023 rules address this by prohibiting certain preferential terms that would have a material negative effect on other investors unless disclosed.
Failure to update side letters when the main agreement is amended: If the main agreement is amended but the side letter is not updated, the side letter may reference provisions that no longer exist or contain modifications that conflict with the amended main agreement. Include a provision in the side letter requiring review and update whenever the main agreement is materially amended.

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Jurisdiction Notes

United States: Side letters are enforceable under general state contract law, subject to the parol evidence rule and the specific terms of any integration clause in the main agreement. Delaware courts have consistently enforced side letters in the fund formation context, treating them as separate contracts that modify the LP's rights under the partnership agreement. The SEC's 2023 Private Fund Adviser Rules (under the Investment Advisers Act) introduced significant new requirements: preferential treatment (including through side letters) that provides material negative effects on other investors is restricted, and all preferential terms must be disclosed to current and prospective investors annually. These rules apply to SEC-registered investment advisers and have transformed side letter practice. State fiduciary duty principles also apply: a GP that grants preferential terms to one LP at the expense of others may face fiduciary duty claims, though most partnership agreements contain fiduciary duty waivers to the extent permitted by Delaware law (DRULPA Section 17-1101).

United Kingdom: English law enforces side letters as binding contracts provided the standard formation requirements are met (offer, acceptance, consideration, intention to create legal relations). The parol evidence rule applies more flexibly under English law than under US law, and courts are generally willing to consider side letters alongside the main agreement. The FCA's regulatory framework for alternative investment fund managers (AIFMD, as implemented in the UK) does not specifically address side letter practices but imposes general requirements of fair treatment of investors. The UK Limited Partnerships Act 1907 does not address side letter enforceability, leaving the matter to general contract principles. Industry bodies, including the BVCA (British Venture Capital Association), have published guidance on side letter best practices recommending transparency and consistency.

European Union and Other Jurisdictions: The EU's AIFMD (Alternative Investment Fund Managers Directive) requires fair treatment of investors, which has been interpreted by some national regulators as limiting the extent to which side letters can grant preferential terms to specific investors. Luxembourg (a major fund domicile) generally enforces side letters under the Civil Code's freedom-of-contract principles, though the CSSF (Commission de Surveillance du Secteur Financier) expects fund managers to disclose material side letter terms. In the Cayman Islands (another major fund domicile), side letters are enforceable under common law principles, and the Cayman Islands Monetary Authority (CIMA) does not specifically regulate side letter practices. In Singapore, the MAS (Monetary Authority of Singapore) expects fair treatment of investors in authorized schemes and requires disclosure of preferential terms. Indian law recognizes side letters as supplementary agreements, but they must comply with the Indian Stamp Act requirements and, in the case of foreign investment, RBI pricing and reporting regulations.

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Related Clauses

Entire Agreement Clause - The primary tension point for side letters; the entire agreement clause may render a side letter unenforceable if not properly addressed in both documents.
Amendment Clause - Defines the formal process for modifying the main agreement; side letters operate as an alternative to formal amendment, raising questions about whether they comply with amendment requirements.
Confidentiality Clause - Governs the treatment of side letter terms and existence; particularly sensitive in fund formation where different investors receive different terms.
Most-Favored-Nation Clause - The mechanism by which side letter benefits spread across multiple parties; MFN elections are the primary administrative challenge in fund side letter management.
Representations and Warranties - Side letters in M&A may modify or supplement representations; coordination between the main agreement reps and side letter modifications is essential.
Assignment Clause - Side letter rights may or may not be assignable depending on the terms; address whether side letter benefits transfer with the main agreement upon assignment.

This glossary entry is provided for informational purposes only and does not constitute legal advice. Side letter practice involves complex interactions among contract law, securities regulation, fiduciary duty principles, and fund governance requirements that vary by jurisdiction and transaction type. The SEC's 2023 Private Fund Adviser Rules have materially changed the regulatory landscape for side letters in fund formation. Consult qualified legal counsel before drafting, negotiating, or relying on side letters in any transaction.