Side letters in venture funds, in plain English

A side letter is the part of the deal that did not fit in the LPA. That is the whole concept. Everything else is detail.

The reason side letters exist at all is that a limited partnership agreement is the same document for every investor. Most LPs accept that. A handful of LPs will not, either because they have institutional rules about what they will sign or because they have negotiated themselves into a status that justifies a one-off. Those are the LPs that ask for a side letter.

What is actually in them

Side letters are not random favors. Almost every one is built from a short list of recurring provisions, and once you have read a dozen the pattern is obvious.

Most-favored-nation rights are the headline. An LP with MFN gets the benefit of any better terms granted to a comparable LP, usually with carve-outs and a category-based scoping. This is the provision that scares fund admins because tracking it across fifty side letters over ten years is genuinely hard.

Reporting and audit rights come next. Some LPs need quarterly reports in a specific format, or a contractual right to audit the fund accounts at their own cost. These provisions are real operational drag for the manager and are worth negotiating tightly at signing.

Excuse rights let an LP opt out of a specific investment, usually for legal or regulatory reasons. They are not a license to second-guess the manager. Drafting matters a lot here because a poorly scoped excuse right becomes an investment-by-investment negotiation.

Co-investment rights, capacity rights, key person provisions, expense allocations, transfer restrictions, ERISA representations. The list goes on, and almost every category has a market range and a manager-favorable variant.

Where offshore comes in

When the fund has a Cayman parallel, side letters have to be granted at both the U.S. and Cayman level for any LP that invested in both. That means two documents, two countersignatures, and two governing law clauses. The temptation to "just mirror it" should be resisted, because Cayman law treats fiduciary duty and conflicts very differently than Delaware does. The cleanest approach is one operative side letter plus a short letter at the parallel entity adopting the same terms by reference, with a carve-out for jurisdiction-specific provisions.

How to read one fast

The shortest read I can recommend is a three-pass review. First pass, find the MFN scope. Second pass, list every operational obligation on the manager. Third pass, look for anything that purports to override the LPA, and either reject it or copy it into the LPA itself for everyone.

The third pass is the most often skipped and the one that costs managers the most over time. A side letter that overrides a fundamental LPA provision creates an inconsistency every future LP has to be told about. The clean answer is to amend the LPA. The fast answer is to let it sit in the side letter and hope nobody notices. Most managers take the fast answer. Most managers regret it.