Why does Side Letter matter?
It lets a founder grant one investor something specific (extra information rights, a modified pro-rata allocation, a most-favored-nation promise relative to future side letters) without renegotiating the entire round's standard documents for every investor. But the accumulation of side letters across multiple rounds and investors can quietly create a tangle of inconsistent, sometimes conflicting promises that is easy to lose track of and expensive to reconcile when every commitment has to be honored simultaneously, such as during an acquisition.
What does Side Letter look like in practice?
Suppose a strategic investor in a Series A insists on a right of first refusal on a future partnership deal as a condition of investing, a term the other Series A investors do not have and would not want extended to them. Rather than adding it to the main financing documents everyone signs, the company and that investor sign a side letter granting just that specific right, keeping the standard round documents clean while still meeting the strategic investor's specific ask.
What are the common mistakes with Side Letter?
- Signing side letters without a central log tracking which investors hold which extra rights, making it hard to answer what has actually been promised, to whom, years later.
- Granting a side letter commitment that conflicts with a right already granted to another investor in the standard documents, discovered only when both are invoked at once.
- Treating side letters as fully private when many contain a most-favored-nation clause requiring other investors be offered the same terms if asked.
- Not surfacing all outstanding side letters during acquisition or later-round diligence, where every commitment needs to be accounted for and satisfied.
Related concepts
- Most Favored Nation (MFN) ClauseA provision, common in bridge financings and early SAFEs, giving an investor the right to automatically upgrade to better terms if the company later gives a subsequent investor in the same round more favorable terms.
- Investor Rights Agreement (IRA)One of the core financing documents in a priced round that bundles an investor's ongoing rights (information rights, pro-rata rights, and registration rights for a future IPO) into a single agreement separate from the stock purchase itself.
- Due Diligence Data RoomA secure, organized repository of a company's key documents (financials, contracts, cap table, IP filings, HR records) assembled for a buyer's or investor's legal, financial, and operational review before a financing or acquisition closes.