What Is a Side Letter?
A side letter is a supplementary agreement executed alongside a main contract — such as a merger agreement, limited partnership agreement, or subscription agreement — that modifies specific terms for one or more parties without changing the main document. In M&A, side letters are used to grant specific concessions, accommodations, or additional rights to individual parties that would be impractical or inappropriate to include in the primary agreement.
Side letters are ubiquitous in both M&A transactions and PE fund formation. They allow deal parties to negotiate bespoke terms while maintaining a clean primary agreement.
Side Letters in M&A Transactions
Common Uses
| Purpose | Example |
|---|---|
| Management arrangements | Employment terms, retention bonuses, equity rollover for key executives |
| Specific indemnities | Buyer agrees to indemnify specific individuals for pre-closing matters |
| Regulatory commitments | Parties agree to specific actions to obtain regulatory clearance |
| Tax elections | Agreement on tax treatment of specific deal components |
| Transition services | Terms for services the seller will provide post-closing |
| Non-compete modifications | Adjusted non-compete terms for specific individuals |
Key Considerations
- Disclosure — side letters may need to be disclosed to other deal parties, regulators, or shareholders
- Consistency — terms must not contradict the main agreement (or if they do, the side letter must explicitly state which prevails)
- Disclosure schedules — material side letters are typically listed in the disclosure schedules
- Confidentiality — side letters often contain sensitive terms (compensation, specific indemnities) that parties wish to keep confidential
Side Letters in PE Fund Formation
LP Side Letters
Side letters are most prevalent in PE fund formation, where large LPs negotiate bespoke terms:
| Term | Description |
|---|---|
| Fee discounts | Reduced management fee or carry for large commitments |
| Co-investment rights | Right to invest alongside the fund in specific deals |
| Transparency | Enhanced reporting, portfolio company information, or audit rights |
| Transfer rights | Ability to transfer LP interests with fewer restrictions |
| Key person provisions | Additional protections if specified GP principals depart |
| ESG requirements | Specific environmental, social, and governance reporting |
| Excuse/exclusion rights | Ability to opt out of investments in specific sectors or geographies |
| Most favoured nation (MFN) | Right to receive any better terms granted to other LPs |
Most Favoured Nation Clauses
MFN provisions are a critical feature of PE side letters:
- LPs with MFN rights can elect to receive the benefit of any more favourable term granted to another LP
- Subject to certain carve-outs (fee discounts above a minimum commitment threshold, regulatory-driven accommodations)
- GPs must disclose the universe of side letter provisions to MFN-eligible LPs
According to the Institutional Limited Partners Association (ILPA), over 80% of institutional LPs negotiate side letters when committing to PE funds, with fee arrangements and co-investment rights being the most commonly negotiated terms.
Legal and Practical Issues
Enforceability
- Side letters are legally binding contracts when properly executed
- Must satisfy basic contract formation requirements (offer, acceptance, consideration)
- May be subject to “entire agreement” clauses in the main document — the side letter must be explicitly carved out
Disclosure Requirements
- SEC-registered funds — side letters must be disclosed as material contracts
- Regulatory filings — material side letters in public M&A may need to be filed with securities regulators
- Shareholder votes — management side letters in public company acquisitions may be material to shareholder decision-making
APAC Context
Australia — side letters in Australian M&A and PE transactions are common, particularly for management arrangements in scheme of arrangement transactions. The Corporations Act requires disclosure of material side arrangements in the scheme booklet.
Japan — side letters (saido retā or betsu gōi) are used in Japanese M&A to address matters that are culturally or practically difficult to include in the main agreement. Management retention and transition arrangements are frequently documented in side letters.
India — side letters in Indian M&A transactions must be carefully structured to comply with SEBI regulations (for listed companies) and the Companies Act. Material side arrangements may need to be disclosed to shareholders and regulators.
“Side letters are the deal-within-the-deal — they contain the bespoke arrangements that make complex transactions work for individual parties,” notes Daniel Bae, founder of Amafi. “In APAC cross-border transactions, side letters often address jurisdiction-specific regulatory and tax requirements that cannot be standardised in the main agreement.”
Structuring M&A transactions across Asia Pacific? Amafi helps companies and investors navigate deal documentation and negotiation. Learn more.