The Terms One Investor Receives and Nobody Else Sees
A private fund has one set of governing documents and, alongside them, a stack of individually negotiated agreements granting particular investors better terms. Whether you know what is in them depends on how much you committed.
The Documents Behind the Documents
A private fund is governed by a limited partnership agreement that applies to every investor. In practice that agreement is not the complete deal. Alongside it sit side letters, bilateral agreements between the manager and individual investors modifying the terms as they apply to that investor.
They are standard rather than exceptional. Large funds routinely execute dozens, and the aggregate effect can be that the headline terms in the partnership agreement describe the deal received by nobody of significance.
What Gets Negotiated
| Provision | Typical Beneficiary |
|---|---|
| Management fee or carry discount | Large commitments, anchor investors |
| Co investment rights | Investors wanting to deploy more at lower fees |
| Enhanced reporting and transparency | Public pensions with disclosure obligations |
| Excuse rights from specific investments | Investors with legal or policy restrictions |
| Advisory committee seat | Largest investors |
| Key person and successor provisions | Sophisticated institutions |
| Transfer and withdrawal flexibility | Rare and valuable |
Several of these are entirely legitimate and reflect genuine differences among investors rather than favouritism. A public pension subject to freedom of information laws needs reporting arrangements a family office does not. An investor prohibited by policy from holding tobacco or firearms exposure needs an excuse right allowing it to sit out a specific deal.
Others are pure economics. Fee discounts for size are ordinary volume pricing. Anchor investors who commit early, when the fund has no track record and needs credibility to attract others, receive better terms for taking that risk, which is the same logic as a cornerstone investor in a public offering.
The Provision That Causes the Real Problem
The terms that genuinely disadvantage other investors are the liquidity and information ones, and they behave differently from fee discounts.
A fee discount to one investor costs the manager, not the other investors. But a right allowing one investor to withdraw or transfer more freely, or to receive portfolio information others do not, can transfer value between investors rather than from the manager. In a stressed period, an investor with superior information or an easier exit is advantaged at the expense of those without.
This is why regulators focused specifically on preferential redemption and preferential information rights rather than on side letters in general.
A fee break given to a large investor is a discount. A liquidity right given to one investor is a claim on the same pool everybody else is in. Those two things get filed in the same drawer and they are not the same kind of term.
How Investors Try to Protect Themselves
The instrument is the most favoured nation clause, under which an investor is entitled to elect any better term granted to another investor in the same fund. It sounds like a complete solution and is generally not one, for several reasons.
MFN rights are usually tiered by commitment size, so an investor can only elect terms granted to investors of the same size or smaller. Certain categories are carved out entirely, commonly including terms driven by regulatory or tax status specific to another investor, and often including advisory committee seats and co investment rights, which are precisely the terms with the most value.
The process also requires the manager to disclose a schedule of side letter terms so investors can elect, and the quality of that disclosure varies. An investor receiving a summary rather than the underlying language may not be able to evaluate what it is declining.
The Regulatory Attempt and What Happened to It
American regulators adopted rules in 2023 addressing exactly these concerns, including restrictions on granting preferential redemption or information rights where they would have a material negative effect on other investors, and requirements to disclose preferential terms to all investors.
Industry groups challenged the rules and a federal appeals court vacated them in 2024, holding that the agency had exceeded its statutory authority. The practical result is that the disclosure and fairness questions the rules addressed remain matters of negotiation and market practice rather than regulation, which puts the burden back on investors to ask.
What This Means in Practice
For an investor, the operative questions are whether an MFN right is offered, what its tiering threshold is, which categories are carved out, whether the disclosure will include actual language or summaries, and how long the election window is. For anyone assessing a manager, willingness to be transparent about side letter practice is a reasonable proxy for how it will handle other conflicts.
And for understanding the industry generally, the useful correction is that published fund terms describe a starting point. The distribution of actual terms is wider than the documents suggest, and it correlates almost entirely with negotiating leverage.
The Bottom Line
Side letters exist because investors in a single fund genuinely differ in size, legal status, and needs, and they persist because the manager has an interest in negotiating privately with each one. Most of what they contain is defensible. The terms worth scrutinising are the ones granting differential liquidity or information, because those redistribute among investors rather than between the investor and the manager. The regulatory effort to address that distinction was struck down, which leaves it exactly where it has always been: in whether you thought to ask before you signed.