Side letters are private addenda to a fund's LPA that grant specific terms to specific investors. The MFN clause — most favored nation — is the LP's mechanism for ensuring the terms in their side letter aren't quietly worse than what the GP gave another LP. Both are standard. Neither is as protective as it sounds.
What side letters do
Almost every institutional fund has multiple side letters. Common provisions include:
- Fee reductions. A 25 bps break on the management fee is the most common. Sometimes a step-down schedule based on commitment size.
- Co-investment rights.A right to invest alongside the fund in specific deals at no fee, no carry. Highly valued by sophisticated LPs because it's economically equivalent to a fee discount.
- Reporting customization. Bespoke quarterly letters, customized capital account statements, ESG reporting, etc.
- Excuse rights. The LP can opt out of specific investments (e.g. a tax-exempt LP excused from UBTI-generating deals).
- Transfer rights. Pre-approved consent for transfer to certain affiliates or in specific situations.
- Notice rights. Faster notice on key-person events, GP removal, or amendment proposals.
- Side letter
- A private addendum to a fund's LPA modifying or supplementing the LPA's terms for a specific LP. Side letters are contractual but not part of the public LPA.
What MFN clauses do
- MFN (Most Favored Nation)
- A right granted to certain LPs to receive the same beneficial provisions the GP grants to any other LP via side letter. In practice, MFNs are usually limited by scope.
The MFN protects the LP from being undercut. If LP A has a side letter granting a 25 bps fee discount and LP B negotiates a 50 bps discount later, LP A's MFN gives them the right to elect into the better discount. Without an MFN, LP A would have no way to know about LP B's deal.
Where MFNs fail to protect
MFN scope is the load-bearing detail. Three common limitations:
- Commitment-size tiers.An MFN that only sees side letters from LPs of “equal or smaller commitment” — meaning a $25M LP's MFN doesn't reach a $100M LP's deals. The bigger the LP, the better deal they got, and the smaller LP's MFN can't see it.
- Investor-type carve-outs."MFN doesn't apply to side letters with affiliated funds, employee vehicles, or strategic investors." Strategic investors often get the best terms, and they're typically carved out.
- Categorical exclusions."MFN doesn't apply to economic terms, tax provisions, or transfer rights." Each carve-out reduces the MFN's reach. Some MFNs are scoped so narrowly they're effectively meaningless.
The MFN process
At a fund's final close, the GP typically circulates a side-letter summary to LPs with MFN rights. The summary lists the provisions granted to other LPs (often anonymized or categorized). Each MFN-eligible LP has a window — typically 30-60 days — to elect provisions they'd like to adopt into their own side letter.
Some LPs treat this election as a checkbox exercise. Sophisticated ones treat it as a meaningful diligence event — reading every provision available, comparing to their existing side letter, and electing into anything beneficial. The economic difference between elections-claimed and elections-skipped can be meaningful over a fund's life.
What to negotiate
For a smaller LP, the practical asks in side-letter negotiation are:
- The MFN itself— most institutional funds grant MFNs above some commitment threshold. Negotiate for the MFN above whatever commitment you're writing.
- Broad MFN scope — push back on commitment-size tiers, investor-type carve-outs, and categorical exclusions.
- Co-investment access— even a modest pro-rata right is meaningful over a fund's life.
- Fee discount — 10-25 bps is gettable for most institutional commitments above $5M.
- Excuse rights — at minimum, excuse from investments that violate your investment policy or tax status.
For most LPs, the side letter is the only mechanism for actually improving on the LPA's default terms. The LPA is what the GP wants to give you; the side letter is what you can negotiate.