A Guide to Side Letters

Side letters have become increasingly popular in venture capital over recent years. But despite their recent popularity, they remain a complex and often misunderstood topic. Today, we’re bringing you a guide to side (or should we say, Syde) letters in hopes of continuing to educate and empower new and aspiring venture investors.   

A side letter is essentially a secondary agreement used to create bespoke terms between two parties. Side letters can exist between venture capitalists (including fund managers/GPs and deal leads) and their limited partners (LPs), as well as between startup companies and their VCs.  The primary purpose of a side letter is to give an investor (either a VC or LP) some special or additional rights that are not granted to all of the other investors involved in a transaction. In almost all cases, these additional rights are advantageous to the investor. 

Side Letters for LPs

Side letters between VCs and LPs allow both parties to agree to terms that may not be applicable to all investors, such as preferential treatment on returns or fees. LPs also use side letters to build in flexibility or leniency around defaulting repercussions, transfer rights, liquidity terms or indemnification. They also allow managers to pre-approve terms for LPs when raising new funds.

Side Letters for VCs

Side letters are also used to establish similar agreements between founders and their VCs. In this case, a side letter might be used to grant a lead or significant investor what are referred to as “advanced rights.” This includes pro rata rights, information rights, or right of first refusal. Side letters can also be used when negotiating a provision that may otherwise not be possible within the scope of only one funding round (for example: "The Company has 15 days after giving notice hereunder during which it may provide information relating to any proposed new financing transaction").

Flexibility

The use of side letters has increased in recent years as both VCs and LPs have looked to make their subscription documents more flexible and relevant to individual investors. This flexibility can make venture investing more feasible or attractive to a greater number of investors, especially as it relates to things like lower minimum investments, investment thesis, and fee structures. But establishing and managing side letters can often be a pain for VCs. They create operational burden, require time (and money) spent on legal counsel, and may create additional obligations or restrictions for the manager. 

This begs the question: why not just create flexible agreements to begin with?

At Sydecar, we’re dedicated to creating standards for deal execution that build in flexibility where it really matters. Our product allows you to create signature-ready subscription agreements with variable economics (fees and carry) for each of your LPs without having to create individual side letters. We understand that our customers care more about efficient, reliable, and cost-effective deal execution than about negotiating every little term of an agreement with their LPs. But we also acknowledge the importance of flexibility. Our customers use Sydecar’s variable fees to: 

• Present higher carry to investors who are not part of their existing investor community

• Offer reduced carry to an individual investor who introduced them to a founder 

• Offer reduced carry to fund LPs who chose to come into a sidecar deal

If you’re looking for an easier way to create flexibility for your investors without the hassle of side letters, we’d love to hear from you. Reach out at hello@sydecar.io