Eventually while raising capital for a private fund, you will likely be asked by several potential investors to participate in a side letter. A side letter is an arrangement between the fund and one particular financier to differ the regards to the limited collaboration arrangement with respect to that specific financier (generally to the advantage of the financier).
Whether it makes monetary sense for a fund to approval to an ask for a side letter is ultimately a company decision, but it is necessary to comprehend the legal considerations that develop in connection with such a demand. Consenting to some kinds of side letters bring the risk of lawsuits from the other investors or enforcement actions by securities regulators.
Sometimes these side letters are borne of requirement for the investor to participate in the fund, either due to regulative requirements or to commitments it needs to other celebrations (such as its own investors). Other times these side letters are the result of the financier trying to work out a better offer for itself. Not all investors are produced equal and some have the utilize to require side letters with specific terms, while others do not.
Common Side Letter Requests
The most typical side letter demand is for a partial or complete waiver of the fund managers costs (either the management cost, efficiency fee/carried interest, or both) for the financier asking for the side letter. Another typical request is for a relaxation of the lock-up requirements for the investor, which provide that investor the right to withdraw his or her funds at an earlier date than other investors. Opposite letter requests may consist of approving more access to the investor to information about the fund. Lastly, some investors might desire “Most Favored Nation” (MFN) stipulations which basically offer those investors the right to obtain any advantage bestowed on other investors via a side letter.
Legal Risks of Side Letters for Fund Managers
Other typical side letter plans do trigger prospective legal concerns for fund supervisors. For instance, permitting an investor with a side letter to exit the fund early could trigger the fund manager to face a claim for breach of its fiduciary task to the other financiers, since they might declare that they were damaged by the side letter. In a scenario where the fund is unable to fulfill all of the asked for redemptions, the investors that do not have a side letter permitting an early withdrawal are at a disadvantage, since the investors that do have such a side letter may have drained the liquidity from the fund by the time the other financiers are eligible to ask for a redemption.
In addition, the Securities Exchange Commission and state securities regulators might and frequently do bring claims against fund supervisors based on the very same concerns. They might argue that the fund manager failed to satisfy disclosure and transparency requirements by not adequately alerting potential and current financiers of the side letter obligations or that fiduciary tasks owed to the investors were violated when the fund supervisor concurred to a side letter with a financier that disadvantaged the other financiers.
In the case where a supervisor waives its fee with regard to a particular investor, there is usually no significant issue, since that cost waiver doesnt adversely affect the other investors. The fund manager can charge the charge divulged in the private positioning memorandum and restricted partnership agreement to the other investors, while likewise waiving that cost with regard to the investor that asked for the waiver.
Side letters that approve a particular investor extra info the other investors are not privy to might be proper in certain circumstances. If the extra access to details can be utilized by the investor to figure out when they should make a redemption demand, then such rights may downside the other investors, leading to litigation by those other financiers later.
For many fund managers, specifically those early in their professions, acquiring capital and new investors is the biggest difficulty, therefore the temptation is great to accede to side letter demands from financiers that want make a big investment in the fund. When the investor is demanding the side letter just prior to closing and may have the fund managers over a proverbial barrel, this can be particularly real. There are a number of dangers that need to be born in mind when working out and drawing up such arrangements.
Best Practices in Entering into Side Letters
Another common request is for a relaxation of the lock-up requirements for the financier, which provide that financier the right to withdraw his or her funds at an earlier date than other investors. Some financiers might desire “Most Favored Nation” (MFN) provisions which basically give those investors the right to acquire any benefit bestowed on other financiers by means of a side letter.
The funds limited collaboration contract and personal positioning memorandum need to consist of language that signals investors to the possibility that the fund lots of grant side letter requests to particular financiers.
© 2017 Alexander J. Davie– This short article is for general information only. The information provided should not be interpreted to be formal legal suggestions nor the formation of a lawyer/client relationship.
By dealing with fund legal counsel to draft and work out side letters that are in accordance with the limited partnership contract, fiduciary duties, disclosure requirements, and other legal issues, a fund manager can restrict the potential for a side letter to trigger issues later on down the roadway.
For lots of fund supervisors, specifically those early in their professions, acquiring capital and brand-new financiers is the most significant challenge, and so the temptation is terrific to accede to side letter demands from investors that are willing make a large financial investment in the fund. Enabling an investor with a side letter to leave the fund early might cause the fund manager to deal with a claim for breach of its fiduciary task to the other financiers, since they might claim that they were harmed by the side letter. In a situation where the fund is not able to satisfy all of the asked for redemptions, the financiers that do not have a side letter permitting for an early withdrawal are at a downside, due to the fact that the investors that do have such a side letter may have drained pipes the liquidity from the fund by the time the other investors are eligible to ask for a redemption.
Fund managers need to likewise ensure that they do not participate in any oral side letters. All arrangements to differ the terms of the minimal collaboration agreement ought to remain in writing. Typically the financiers asking for the side letter will demand this anyway, however its essential for fund supervisors not to make pledges loosely.
When evaluating each side letter request, the most crucial concern for fund managers is to determine whether the regards to the proposed side letter impact their fiduciary tasks to other investors. This decision should be made in assessment with the funds legal counsel. When the regards to the side letter do not affect other financiers, they may frequently be entered into without revealing the terms to other financiers. When other financiers are impacted, its possible that the disclosure of the terms of the side letter to the other financiers may suffice to deal with such issues. More frequently, the fund manager need to look for the approval of the other investors to the plan or not participate in such plan at all.
In addition, mindful attention should be offered to fund supervisors to what other obligations are triggered by getting in into side letters. For instance, those other investors with MFN status may require to be without delay notified of a side letter and used the exact same benefits.
While fund supervisors might face an enormous temptation to grant side letter requests, they ought to exercise due factor to consider and care in what requests they approve and how they give them.