Side Letters in Funding Rounds Explained
The main documents of a funding round get all the attention, but some of the most important promises live in a short extra agreement called a side letter. Side letters give one investor rights that the others do not get. Handled well, they help close a round. Handled carelessly, they create obligations you forget about until they cause trouble. Here is what founders need to know.
Key takeaways
- A side letter gives a specific investor extra rights outside the main documents, such as information rights, pro rata rights or most favored nation (MFN) terms.
- They are common and usually reasonable, but each one is a promise your company must keep for years.
- MFN terms can spread one investor's special rights to others, so know exactly what you have granted.
- Keep a simple register of every side letter and review it before each new round.
If you are raising a seed or early-stage round, there is a good chance at least one investor will ask for a side letter. It might be a fund that needs regular financial reports for its own investors, an angel who wants the right to join your next round, or a strategic investor with specific concerns. None of this is unusual. The challenge is that side letters are easy to sign in the final rush to close and easy to forget afterward.
This article is general information to help you understand side letters, not legal advice. Your lawyer should review any side letter before you sign it, because the details matter and rules differ by country.
What a side letter is
A side letter is a short agreement between your company and one investor, signed alongside the main round documents. It adds to, or sometimes adjusts, the rights that investor gets under the standard terms everyone else signs.
Think of the main documents as the shared rulebook for the round. Every investor in that round usually gets the same rights for the same class of shares. A side letter is a personal note that says, in effect, "and for this investor, we also agree to the following."
Why investors ask for them
- Their own reporting duties. Funds often have to report to the people who invested in them, so they may need specific financial information on a set schedule.
- Protecting their position. An investor may want the right to keep their ownership level in future rounds.
- Fairness worries. An early or large investor may want assurance that later investors will not get better terms without them.
- Specific policies. Some investors have internal rules on topics such as data handling, sanctions or industries they cannot support, and they need the company to confirm certain points.
Why they are not in the main documents
Putting every special request into the main documents would make them messy and would give every investor the same extra rights. A side letter keeps the main terms clean and standard while still meeting one investor's needs. It also means smaller investors do not have to review rights that do not affect them.
Common rights you will see in side letters
Side letters vary, but a handful of rights come up again and again. Here is what each one means in plain language.
Information rights
These give the investor access to regular information about the company, such as monthly or quarterly financial statements, an annual budget or year-end accounts. Information rights are among the most common side letter terms. Before agreeing, check that you can actually produce what is promised on time, every time.
Pro rata rights
A pro rata right lets the investor buy enough shares in a future round to keep their percentage ownership. For example, an investor who owns a certain share of the company after this round could invest again later to stay at that level. These rights can be valuable to investors, but if you grant many of them, they can limit how much room you have for new investors in the next round.
Most favored nation (MFN) terms
An MFN clause says that if the company later gives another investor better terms, this investor can have those better terms too. MFN clauses are common in SAFEs and early convertible instruments, and they can also appear in side letters. They sound harmless, but they can turn one generous concession into a promise to many investors at once.
Other terms you may see
- Board observer rights. The right to attend board meetings without a vote.
- Consultation rights. A promise to talk to the investor before certain decisions.
- Confidentiality adjustments. Permission for a fund to share some information with its own investors or advisers.
- Policy confirmations. Statements that the company follows certain laws or will not use the money for certain purposes.
Pro tip
When an investor sends a side letter request, ask them to explain the reason behind each term. Often the real need is narrower than the first draft. A fund that asks for "monthly financials" may be fine with quarterly ones if that is what its own reporting cycle needs.
How MFN terms can multiply your promises
MFN terms deserve extra attention because their effect is not obvious when you sign them. Suppose you give Investor A an MFN clause. Later in the same round, you agree to give Investor B quarterly financial reports and a board observer seat. If Investor A's MFN covers those kinds of rights, Investor A may now be entitled to them as well.
Now imagine you have five investors with MFN clauses. One concession to a late investor could become five concessions. That is why careful founders and lawyers limit MFN clauses in a few ways:
- Scope. The MFN covers only certain types of rights, such as economic terms, and not every special arrangement.
- Size. Only investors putting in at least a certain amount can claim MFN benefits from others.
- Exclusions. Rights tied to a specific investor's legal or regulatory situation are carved out, because they make no sense for anyone else.
- Time limit. The MFN applies only within the current round, not forever.
Common mistake
Agreeing to a broad MFN clause on the first side letter and then negotiating the rest of the round without remembering it. Before you agree to anything special for a later investor, check which earlier investors have MFN rights and what those rights cover.
How to handle a side letter request step by step
You do not need to fear side letters. You just need a calm, consistent process. Here is one that works for most early-stage rounds.
- Ask early. Near the start of the round, ask each lead and major investor whether they will need a side letter. Surprises on closing day lead to rushed decisions.
- Get the draft in writing. Ask for the investor's proposed side letter or a list of requested terms, and share it with your lawyer straight away.
- Understand the reason. For each term, know why the investor needs it. This helps you suggest narrower wording that still meets the need.
- Check existing promises. Compare the request against MFN clauses and side letters you have already signed, in this round and earlier ones.
- Test whether you can deliver. If you promise quarterly reports within 30 days of quarter end, make sure your bookkeeping can actually do that.
- Sign and record. Once signed, add the side letter to your register and set reminders for any recurring obligations.
- Tell the people who need to know. Your finance lead, your co-founders and your board should know what has been promised and to whom.
A side letter register template
A side letter is only useful if someone remembers it exists. Keep a simple register in a shared spreadsheet and store a copy of each signed letter in your data room. The investors and terms below are made-up examples.
| Investor | Date signed | Rights granted | Recurring obligation | MFN? | Owner | Next review |
|---|---|---|---|---|---|---|
| Example Fund I | March (example) | Quarterly financials, annual budget | Send within 45 days of quarter end | No | Finance lead | Before next round |
| Example Angel | March (example) | Pro rata right in next priced round | Offer allocation when next round opens | Yes, economic terms only | CEO | Before next round |
| Example Strategic Investor | April (example) | Board observer seat, confidentiality limits | Invite to board meetings, exclude sensitive items | No | CEO | Each board meeting |
Add a column for the expiry or end condition of each right. Many rights end at a later funding round, an exit or a fixed date, and it helps to know when an obligation stops.
Hypothetical example
Imagine Amira, the founder of a small climate software startup, closing a seed round with three investors. The lead fund asks for quarterly financials. A large angel asks for a pro rata right and a broad MFN. Before signing, Amira's lawyer narrows the MFN to economic terms only. Two weeks later, a strategic investor joins and asks for a board observer seat. Because the angel's MFN no longer covers governance rights, Amira can agree to the observer seat without offering it to everyone. She logs all three letters in her register and sets quarterly reminders. (The people, company and terms are made up for illustration.)
What side letters mean for your next round
Side letters do not disappear when the round closes. New investors in your next round will usually want to see them during their review, because those promises can affect their own rights. A forgotten pro rata right, for example, can complicate how much of the next round is available to new money.
Before you start your next raise, take an hour to review your register:
- Check what is still active. Some rights end automatically at the next priced round. Others continue.
- Prepare for pro rata conversations. Know which investors have the right to invest again and roughly how much that could be.
- Confirm you have kept your promises. If you missed a few quarterly reports, it is better to fix that now than to have it surface during a review.
- Consider tidying up. In a later round, investors and the company sometimes agree to replace older side letters with new standard terms. Your lawyer can advise on whether that makes sense.
Your side letter checklist
- Ask each major investor early whether they need a side letter
- Get every request in writing and send it to your lawyer
- Understand the reason behind each requested term
- Check existing MFN clauses before agreeing to new rights
- Confirm you can deliver every recurring obligation on time
- Log each signed letter in a side letter register
- Store copies in your data room and set reminders
- Review the register before your next round
Frequently asked questions
Do other investors get to see my side letters?
It depends on the terms of each letter and the main documents. Some side letters are confidential, while MFN clauses often require you to share the terms other investors received. Ask your lawyer what disclosure each letter requires.
Are side letters a red flag for new investors?
Not usually. They are common, especially with institutional investors. What concerns new investors is a pile of unusual rights, broad MFN clauses or promises the company has not kept.
Can I say no to a side letter request?
Yes. You can decline or negotiate any term. Explaining your reasons, such as wanting all investors treated equally or not being able to deliver monthly reports, is a normal part of negotiation.
Do side letters apply to SAFEs and convertible notes?
They can. Investors in SAFEs or notes sometimes ask for side letters covering information rights or pro rata rights, since the instruments themselves may not include them. Treat them with the same care as in a priced round.
Related reading
The bottom line
Side letters are a normal part of fundraising, and they often help a round close smoothly. The risk is not the letters themselves but losing track of them. Understand why each investor needs what they ask for, keep MFN clauses narrow, and only promise what your company can deliver.
Start your side letter register today, even if you have only one letter. Future you, sitting across from a new lead investor, will be glad every promise is written down in one place.
