The MFN clause is what should worry a manager about an anchor's side letter, more than the 1.25%

Question

Take a fund with a 20m target and a 25m hard cap. An anchor offers 5m at first close and their side letter asks for management fee at 1.25 rather than 1.5, no change to the promote, quarterly position-level reporting rather than the fund-level summary everyone else gets, and a co-invest right on anything above a 4m equity check. Assume the LPA has a standard MFN. The worry for the manager is that at second close the side letter schedule gets circulated and every 250k investor elects the fee break, and the fund has handed back 25bps on the whole raise to buy one commitment. Separately, a small manager's accounting usually cannot produce quarterly position-level reporting without adding a person. How are people actually tiering this, and does the reporting request get treated as MFN-electable at all?

Rena Expert · Accepted Answer

MFN in most private fund documents is an election, not an automatic upgrade. At or after each closing you circulate a schedule of the side letter provisions granted so far, and later investors elect which ones they want. The near-universal practice is to tier the election by commitment size, so a provision granted to a 5m investor is only electable by investors committing 5m or more. That is what keeps a 25bps break from spreading to the 250k tickets. Whether your existing LPA actually permits that tiering, and whether a given provision can be excluded from the schedule at all, depends on how your MFN clause is drafted, so your fund counsel has to read it before you promise the anchor anything.

The numbers make the case for tiering obvious. 25bps on 5m is 12.5k a year, call it 62.5k over a five year life. 25bps on the full 20m is 50k a year and 250k over the life, which is real money against your fee budget for staff.

Reporting provisions are the ones people underestimate. Position-level quarterly reporting for one LP is a template you build once and then owe forever, and each cycle it's real analyst hours reconciling to what everyone else received. Sponsors commonly carve regulatory and reporting provisions out of the MFN schedule, and again, whether you can depends on your clause.

The item you haven't raised is the co-invest right. A standing right on every equity check above 4m gives one investor first look at your best allocation, and other LPs will notice when the largest deals arrive with a co-invest already spoken for. Also, one investor holding 20 to 25 percent of the fund means fund two's viability now depends on their re-up decision.

raj_mehta14 · Answer

MFN is rarely automatic. In most LPAs it is an election off a schedule of side letter terms, and the sponsor writes that schedule. The drafting is where the leverage sits, so the real question is whether your MFN language lets you tie a provision to commitment size. If it does, the 250k investors never get to elect the fee break in the first place.

jessreyes12 · Answer

The bit I'd have been too embarrassed to ask in a room: what stops the anchor from just telling other LPs what they got? Confidentiality clause in the side letter, presumably, but LPs talk to each other at conferences constantly and nobody's suing anybody over that.

megan_doyle15 · Answer

Basic question. The LPA is 90-something pages and the side letter is three. Which one actually controls if they disagree?

tonyv88 · Answer

@megan_doyle15 the side letter controls, but only between the fund and that one investor. Everyone else still lives under the LPA. And on the reporting piece, position level quarterly means somebody at the asset level is producing a rent roll and a variance schedule per property on a deadline, every quarter, forever. In practice that is the difference between a summary that takes an afternoon to pull and two full days of reconciliation. Price it before you agree to it, because the request always sounds free in the meeting.

sonia_alvarez · Answer

Take the fee break and tier it hard, then think about the concentration. 5m of 20m is a quarter of your fund in one relationship. Lenders ask about LP concentration when they are sizing a subscription line, and if that investor sits out fund two you are rebuilding the base from scratch while your track record is still short. The 12.5k a year is the cheap part of this.

The MFN clause is what should worry a manager about an anchor's side letter, more than the 1.25%

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