One Investor Wants a Side Letter. What Am I Actually Giving Away?
Your fundraising round is almost complete. Most investors have agreed to the standard financing documents.
Then one investor asks for a side letter.
They explain it’s a minor request that won’t affect the rest of the financing. That may be true.
It may also create obligations that continue long after this round has closed. Side letters are legally binding agreements that grant one investor rights beyond those contained in the main financing documents. Understanding exactly what those rights are before signing helps founders avoid unexpected restrictions during future fundraising.
What Is a Side Letter?
A side letter is a separate legal agreement between the company and an individual investor. It grants rights or benefits that do not appear in the standard financing documents signed by the other investors.
Common examples include:
- Additional information rights.
- Pro rata investment rights.
- Most-Favored-Nation (MFN) provisions.
Although the side letter affects only one investor, it becomes a binding contractual obligation for the company.
How Does an MFN Clause Work?
A Most-Favored-Nation (MFN) clause allows an investor to claim certain better terms that the company later grants to another investor.
For example, if a future financing provides more favorable rights and those rights fall within the scope of the MFN provision, the earlier investor may be entitled to receive the same treatment.
MFN clauses commonly appear in SAFEs, convertible notes, and certain side letters.
The exact scope depends on how the provision is drafted.
Why Founders Agree to Side Letters
Side letters are not automatically problematic.
They allow founders to accommodate reasonable requests without renegotiating the primary financing documents for every investor.
For example, a strategic investor may request additional reporting or inspection rights that are appropriate for their particular relationship with the company.
The challenge arises when multiple side letters accumulate over several fundraising rounds.
Each additional agreement creates another long-term obligation that founders must remember and manage.
The Hidden Cost Appears in Future Rounds
The consequences of a side letter often become visible only during the next financing.
A broad MFN clause can reduce flexibility because granting improved terms to one new investor may require extending similar rights to earlier investors.
Similarly, forgotten side letters may create problems during investor due diligence, acquisition reviews, and later financing negotiations.
Keeping accurate records becomes increasingly important as the company grows.
Track Every Side Letter in One Place
Unlike charter documents and financing agreements, side letters are often stored separately.
That makes them easy to overlook.
Founders should maintain a centralized record showing:
- Which investors have side letters.
- The specific rights granted.
- Whether an MFN clause applies.
- Any continuing reporting or participation obligations.
Having this information readily available helps prevent surprises during future diligence exercises.
Negotiate Side Letters Carefully
Not every investor request should be accepted without discussion. Before signing, founders should consider:
- Whether the requested rights are truly necessary.
- Whether the MFN clause is narrowly drafted.
- Whether granting the side letter affects other investors.
- How the obligation may influence future fundraising.
Carefully reviewing these issues early is usually much easier than trying to renegotiate them several years later.
Common Founder Mistakes
- Treating a side letter as routine paperwork: A side letter is a binding legal agreement that may grant additional rights beyond the main financing documents and should receive the same level of review.
- Granting a broad MFN clause without considering future rounds: A broadly drafted MFN may require the company to extend improved financing terms to earlier investors, reducing flexibility during later fundraising.
- Failing to keep track of side letters over time: Because these agreements exist outside the primary financing documents, they are easy to overlook unless they are maintained in a centralized record.
- Not checking whether the requested rights affect existing investor obligations: Granting new rights without reviewing previous agreements can create inconsistencies that become problematic during due diligence or future financings.
10-Minute Side Letter Self Check
- Do I understand every right granted by this side letter?
- Does the agreement include an MFN provision?
- Which future financing terms could trigger that MFN?
- Have I confirmed the side letter does not conflict with existing investor rights?
- Do I maintain a complete record of every side letter signed by the company?
- Would I be able to explain every outstanding side letter during investor due diligence?
If you cannot answer yes to all of these, you are not ready to sign that side letter yet.
Bottom Line
Side letters allow companies to accommodate individual investor requests without changing the primary financing documents, but they also create ongoing legal obligations that may affect future fundraising. Understanding exactly what each side letter grants, limiting MFN provisions where appropriate, and maintaining complete records help founders preserve flexibility as the company continues to grow.
Want to Know What Else Investors Can Slip Into Your Deal?
Schedule a free 30-minute call with our team to discuss your questions and next steps.
Book here: https://calendly.com/primumlaw/30min