Side Letters Explained: What They Are and Why You Should Read Each One Carefully

A side letter is a separate agreement between the company and a specific investor, granting that investor rights or privileges that aren't in the main investment documents. Side letters are normal — almost every priced round has at least one. They're also a category of paperwork that catches founders out when they don't read each one carefully.

This article walks through what side letters typically contain, when to grant them, and the traps that come with stacking them.

When side letters appear

Three common scenarios:

1. A specific investor has unusual requirements. A corporate strategic investor needs regulatory carve-outs. A government-backed fund needs reporting accommodations. A family office wants specific reporting cadence.

2. An investor wants rights that don't naturally fit the main documents. Pro rata for an investor who isn't the lead. Information rights beyond the standard IRA. Most-favoured-nation (MFN) protections.

3. Side letters from earlier rounds carry forward. Each round, side letters from previous rounds may need to be honoured or renegotiated.

What's typically in a side letter

The most common side letter clauses:

Pro rata rights. A non-lead investor wants the right to participate in future rounds at their existing ownership level. We unpack this in pro rata rights explained.

Information rights. Some investors want information rights beyond what's in the IRA — quarterly board updates, monthly metrics, real-time financial dashboards.

Most-favoured-nation (MFN). "If you give any future investor better terms, this investor automatically gets the same." Common in SAFE rounds.

Regulatory accommodations. For corporate or strategic investors, language allowing them to comply with their internal regulatory requirements.

Right of first offer (ROFO) on future rounds. The right to be offered participation in future rounds before others.

Co-sale rights. Sometimes added via side letter for investors not in the main documents.

Specific protective provisions. Custom carve-outs allowing specific actions or limiting them.

Why founders should care

Three reasons.

1. Side letters compound. If five investors each have side letters granting different rights, the cumulative effect on your future flexibility is real. Each additional commitment adds friction to future rounds.

2. They're often less visible than the main documents. A founder reading through the SPA carefully may skip the side letters. They're on different paper, separate signatures, separate filing. But they're equally binding.

3. They sometimes contradict the main documents. A side letter saying "Investor X gets pro rata" needs to align with the main IRA's pro rata language. Inconsistencies cause problems later.

When to grant side letters

Three principles:

1. Grant them sparingly. Side letters are not free. Each one limits future flexibility. Grant only when there's a specific, real reason.

2. Reserve them for important investors. Lead investors often deserve side-letter accommodations. A $25k angel does not.

3. Match the right to the contribution. Pro rata to lead and major participants: yes. MFN to a strategic with regulatory needs: yes. Excessive information rights to a $50k angel: no.

Reading each side letter carefully

When a side letter draft lands, three questions:

1. What right is being granted? State it in plain language. "This says Investor X gets pro rata in all future rounds."

2. What's the practical implication for future rounds? "At Series A, Investor X can participate up to their existing percentage. With 10 angels each holding pro rata, the cumulative participation rights take 30% of any future round."

3. Are there any provisions that limit my future flexibility? "This MFN automatically extends future improved terms to this investor. That means I can't easily structure a future investor's terms to be better."

If you can't articulate clean answers to these three, ask your lawyer.

The "stacking" problem

A common mistake: granting many side letters without modelling the cumulative effect.

Example: you grant pro rata via side letter to:

• Lead investor (logical)
• Two co-leads (logical)
• Three significant angel participants (situational)
• Four smaller angels (questionable)

When you raise Series A, all 10 pro rata holders technically have the right to participate. The new lead investor wants 18% ownership. After existing pro rata participation, the new lead can only get 12%. The deal falls apart, or you spend weeks negotiating each existing investor down.

Avoid this by granting pro rata only to investors who genuinely deserve it.

MFN clauses: read with extra care

MFN clauses ("most favoured nation" — if you give any future investor better terms, this investor automatically gets the same) are particularly subtle.

What MFN typically covers:

• Better economic terms (higher discount, lower cap, etc.).
• Better information rights.
• Better governance rights.

What it sometimes also covers (depending on language):

• Anti-dilution.
• Liquidation preferences.
• Pro rata.

A broadly-drafted MFN can lock you into giving every future improvement to early investors automatically. That's good for them and limiting for you.

If you're signing a SAFE with MFN, read the MFN scope carefully. A narrow MFN (covering only economic terms) is usually fine; a broad MFN (covering everything) is more constraining.

Tracking side letters

Build a simple tracker:

| Investor | Document | Rights granted | Triggers | |----------|----------|----------------|----------| | Sequoia | Side letter v1 | Pro rata, info rights | Future rounds | | Andreessen | Side letter v1 | Pro rata, MFN | Any future SAFE | | Angel A | Side letter v1 | Information rights | Quarterly | | Angel B | None | — | — |

Update at every round. Reference at the next negotiation.

Side letters from earlier rounds

When you raise a new round, existing side letters may need to:

• Be honoured. Most rights carry forward.
• Be renegotiated. Sometimes existing investors voluntarily waive rights to make room for new lead.
• Be terminated. Some side letters specify they expire at certain events.

Plan for this before opening a new round. If existing side letters will block your next round, negotiate the change in advance.

What investors expect

Investors who request side letters are not being unreasonable. Most institutional investors have specific needs that don't fit the main documents perfectly. The question is which requests are reasonable and which are excessive.

Reasonable:

• A regulatory carve-out for a corporate investor.
• Pro rata for a major participant.
• Specific information rights for a fund-of-funds.

Less reasonable:

• Excessive governance rights for a small participant.
• MFN that covers everything.
• Veto rights that aren't in the main protective provisions.

A practical first principle

Read every side letter as if it were the main document. They're equally binding. The discipline of careful reading at each round saves problems at every subsequent round.

Side letters aren't dangerous when treated seriously. They become dangerous when they accumulate without thought. Track them, limit them, and grant them only when there's a clear reason.