Growing side letters creating burden for GPs

Longer and more carefully negotiated fund side letters are resulting in additional administrative burdens for private fund managers, sources tell PE Manager.

Side letters are special agreements – which exist parallel to a fund’s limited partnership agreement (LPA) – made between individual investors and a GP.

In part due to LPs’ growing understanding of the private equity asset class, and a widely reported pendulum of power swinging in investors’ favor at the negotiating table, these side letters are being written with more clauses and provisions relative to years past, sources say. Consequently, GPs are spending more time on the fundraising trail negotiating individual terms and conditions with investors, says one UK-based fund formation lawyer.

At times, negotiating side letters consumes more time than the creation of the LPA itself, the attorney said.

Traditionally, GPs have not viewed side letters with much importance, instead focusing their attention on drafting the LPA, legal sources say. But now co-investments, secondary sales and rights of first refusal on the disposal of assets are being pushed into side letters, resulting in GPs reserving more time to negotiating agreeable side letters.

Part of the problem stems from LPs sending all their fund managers a “standard form side letter” which makes no distinction between one fund advisor to the next, according to sources. And because no attempt is made to fit side letter terms to a particular fund, the end result is more administrative homework for GPs, who must reconcile the request to their particular fund, a second industry lawyer noted.

For more on side letters and how GPs are meeting the challenge of more negotiation on these custom agreements with individual LPs, be sure to check out the December edition of PE Manager.