Side letters offer Family Offices the opportunity to negotiate individual agreements with the General Partner (GP) of a VC fund, allowing them to implement specific preferences and requirements that go beyond the standard fund documentation.
To ensure the side letter doesn’t become a generic addendum, Family Offices should approach the process in a structured manner and define early on which aspects are important to them, especially those not adequately addressed in the Limited Partnership Agreement (LPA). This requires a clear investment objective: What matters most to the Family Office in the context of this particular VC fund? These priorities can then be categorized into “must-haves” and “nice-to-haves.”
Such investment objectives can vary significantly depending on the fund. If the fund invests in sectors where the family is actively involved entrepreneurially, the Family Office may pursue different goals than with a fund lacking that industry focus. In addition to financial interests, there may be a desire to engage with startup founders or gain access to co-investment opportunities.
Early Communication with the GP
Key points should be communicated to the GP as early as possible, especially commercial terms such as fee rebates or a seat on the Limited Partner Advisory Committee (LPAC), which are typically reserved for investors with substantial capital commitments. At the beginning of the fundraising process, GPs are generally more willing to offer concessions in exchange for significant commitments than they are toward the end. An exception may be when the GP struggles to reach the minimum fund size for a closing, but in such cases, the Family Office must ask itself whether it truly wants to invest under those circumstances.
The increasing time pressure as the closing approaches is another reason to address critical points early. Otherwise, there may not be enough time to discuss them thoroughly and persuade the GP of the Family Office’s position. It is also advisable to explain why certain provisions are particularly important or necessary. This not only increases the GP’s understanding of the Family Office’s needs but also compels the GP to provide a more detailed justification for any rejection, rather than simply responding with “we respectfully decline your request.”
Typical Side Letter Provisions Relevant to Family Offices
MFN Clause (Most Favoured Nation)
A side letter is a bilateral agreement between the GP and the investor, effective only between those parties. An MFN clause allows the Family Office to benefit from rights granted to other investors in their side letters, even if those rights or benefits were not initially offered to the Family Office. Typically, MFN clauses include limitations. The right to claim a specific benefit is usually tied to having made a capital commitment in the size at least equal to that of the investor who received the benefit. Rights granted for tax or regulatory reasons are generally excluded from MFN applicability.
LPAC Seat
LPAC seats are usually allocated to investor groups with the largest commitments. If the Family Office does not belong to this group, participation may still be possible if it brings unique industry expertise relevant to the fund’s investment focus, expertise that other LPAC members may lack. Alternatively, the Family Office may negotiate observer rights or enhanced access to LPAC-related information.
Confidentiality Provisions
Confidentiality is important to Family Offices in two aspects: On one hand, they typically prefer that their investment not be publicly promoted by the GP. On the other hand, it may be necessary within the Family Office to share fund or portfolio company information with third parties, for example, when the Family Office leverages resources from the family’s operating business. To preserve confidentiality, it is advisable to limit public disclosure of the Family Office’s involvement to legally required instances and to make any further sharing of information subject to the Family Office’s prior consent.
Co-Investment Rights / Access to Portfolio Companies
These rights are particularly relevant for Family Offices with a connection to the sectors in which the VC fund invests. Regarding co-investments, GPs typically commit only to a best-effort obligation to inform the Family Office of opportunities. As for access to portfolio companies, GPs often organize annual portfolio days. If the Family Office seeks deeper engagement, it may be helpful to offer reciprocal access to its own industry network.
ESG / Exclusion Lists / Excuse Rights
Although most fund agreements already exclude investments in sensitive sectors (e.g., controversial weapons, gambling, pornography), a Family Office may have stricter internal guidelines. These can be implemented via side letters. However, broad exclusions may prevent the fund from investing in certain sectors altogether, affecting all investors. GPs are therefore cautious about agreeing to such terms. In these cases, an excuse right can be negotiated, allowing the Family Office to opt out of specific investments. This may also be relevant if the Family Office’s beneficiaries are subject to non-compete clauses, such as following a business sale. If the Family Office tracks its own ESG metrics, it is important to ensure the GP provides the necessary data via the side letter.
Transfer Rights
The transfer of fund interests requires GP approval. It may be beneficial for the Family Office to secure pre-approval for intra-family transfers in the side letter. Additionally, the side letter should specify that any rights granted therein will transfer to the new holder in the event of a (partial) assignment.
Tax Provisions / Reporting
Especially when investing in foreign funds, German Family Offices must ensure they receive all information required for their tax filings. A market-standard approach has emerged, and tax provisions in side letters tend to be similar. Furthermore, the Family Office should confirm that participation in alternative investment structures is only mandatory if such participation does not result in less favorable tax treatment compared to the main fund investment.
