Side letters customize the operating agreement for individual LPs. Common terms: enhanced reporting, MFN clauses (most-favored-nation), co-investment rights, management- fee discounts on size, ERISA carve-outs for plan investors, UBTI protections for tax-exempt LPs, and consent rights on specific actions (additional debt, related-party transactions).
Side letters in practice and how they interact with the main operating agreement
MFN (most-favored-nation): the LP's right to receive any more-favorable economic or governance term granted to a later-investing LP. Standard for institutional LPs; routinely included in pension and endowment side letters. The MFN typically excludes terms specific to the other LP's regulatory status (e.g., ERISA-only carve-outs).
Co-investment rights: the LP's right to invest pari passu (or with adjusted economics) in additional deals the sponsor brings forward. Typical for large institutional LPs that want to deploy capital into single-asset deals alongside their fund commitment.
Reporting enhancements: monthly or quarterly NAV reporting, ESG disclosures, attribution reporting, and specific format requirements. Institutional LPs often have internal compliance reporting cadences that require GP cooperation.
Fee discounts on size: stepped management-fee discounts based on commitment size. Typical: 100 bps fee on first $25M, 75 bps on next $50M, 50 bps above $75M. The structure rewards anchor LPs and allows the sponsor to scale capital efficiently.
ERISA-related carve-outs: ERISA plan investors require specific representations and structural protections to prevent the deal from being treated as 'plan asset' under ERISA. Standard ERISA carve-outs include the 25% test (LP keeps benefit-plan investor percentage below 25%) and operating-company status compliance.
UBTI protections: tax-exempt LPs (pensions, endowments, IRAs) negotiate carve-outs that limit debt-financed activity, restrict UBTI-generating side businesses, and may require REIT or blocker structures. See the UBTI Q&A for structural detail.
Lender consent angle: most side letters do not directly affect senior loan documents. But side-letter terms that grant individual LPs governance rights (consent on debt, consent on disposition) need to be reviewed against the senior loan's transfer-and-assignment paragraphs to make sure LP consent rights don't accidentally trigger a senior-loan default.
Sources
- Private Funds Statistics (Form PF Aggregate Data) · U.S. Securities and Exchange Commission · 2025-Q3
- Subscription Credit Facility Reporting Template and Capital Call Practices · Institutional Limited Partners Association (ILPA) · 2025