Side Letter Governance - Working Paper N° 710/2023 - Empirical analysis of private equity side letters

Sep 16, 2026

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A standard feature of the private equity industry, “side letters” are confidential agreements granting individual investors special rights beyond those of other investors. Critics argue they favor certain investors, while others view them as efficient price discrimination. This paper offers the first empirical analysis using a hand-collected dataset from thirty years of buyout funds, coding side-letter terms to test common claims. Results show side letters rarely reallocate fund economics and instead largely address regulatory and tax concerns. The study also finds growing length and complexity, higher costs, operational and investment frictions, and an inefficient bargaining arms race driven by lawyer agency costs and contracting frictions, with policy recommendations on regulation or coordinated industry action.

LanguageEnglish

CategoryLetters

FormatPDF

Pages94

Reading Time33 min

AccessFree to download

Abstract

Research approach

Key findings

Implications and policy recommendations

Side Letter Governance Law Working Paper N° 710/2023 June 2023 Elisabeth de Fontenay Duke University Yaron Nili University of Wisconsin-Madison and ECGI © Elisabeth de Fontenay and Yaron Nili 2023. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. This paper can be downloaded without charge from: [http://ssrn.com/abstract_id=4067905](http://ssrn.com/abstract_id=4067905) [https://ecgi.global/content/working-papers](https://ecgi.global/content/working-papers) ECGI Working Paper Series in Law Side Letter Governance Working Paper N° 710/2023 June 2023 Elisabeth de Fontenay Yaron Nili For comments and suggestions, sincere thanks are due to our interviewees and to William Clayton, George Geis, Cathy Hwang, Kobi Kastiel, Ed Rock, and Andrew Tuch, as well as to workshop participants at the 2022 Conference on Empirical Legal Studies, the 2022 Annual Meeting of the American Law and Economics Association, the 2022 BYU Winter Deals Conference, the 2021 ABA Business Law Section Annual Meeting, and the University of Wisconsin Law School faculty seminar. For outstanding research assistance, we thank Jasmine Chen, Megan Christopher, Cody Ciura, Wiley Cole, Katie Gresham, Tianyuan Guan, Rees Horton, Yejin Jang, Jake Joling, Shreya Labh, Fangning Li, Chang Liu, Brenda Luo, Adam Mazin, Samuel Moheban, Patrick O’Malley, Tre Polk, Samuel Ross, Sam Schrader, Sebastian Uribe, Gretchen Winkel, Xiaoyu Zhang, and Zijun Zhao. Any errors are ours alone. © Elisabeth de Fontenay and Yaron Nili 2023. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. Abstract A standard feature of the private equity industry, “side letters” are confidential agreements between the sponsor and individual investors that give the latter special rights, beyond those that apply to other investors in the private equity fund. Yet side letters have become a flashpoint for prominent critics of the industry, who argue that they allow private equity sponsors to benefit their favored investors at the expense of smaller, less sophisticated ones. Others have argued that, to the contrary, side letters are merely an efficient means of price discrimination—charging different prices to different investors, according to their willingness to pay—a practice that is common and well accepted in other industries. We find fault with both views. We provide the first empirical analysis of side letters, which disproves some of the most common claims about their content. Specifically, we code the terms of each side letter in a hand-collected sample from thirty years of buyout funds. Contrary to the conventional wisdom, we find that side letters very rarely grant fee discounts to investors or otherwise reallocate the fund economics among investors. Instead, side letters are mostly designed to accommodate a fund investor’s regulatory and tax concerns. The view shared by both critics and proponents—that side letters are primarily used to treat investors differentially—is largely mistaken. Side letters remain problematic, but for very different reasons than those raised by critics. We show that side letters have grown substantially in both length and complexity over time. They impose significant costs and delay on private equity capital-raising, and they potentially impinge on funds’ operations and investments in unexpected ways. Over time, they have prompted an inefficient arms race among investors, leading to ever longer negotiations and more complex contractual networks for private equity funds, with little benefit for investors or sponsors. Using qualitative interviews with key participants in the industry, we explore the causes, including lawyer agency costs and other contracting frictions. This A

FAQs

What are side letters in private equity funds?

Side letters are confidential agreements between a sponsor and individual investors that grant those investors special rights beyond what other investors receive in the same private equity fund.

How does the paper evaluate the competing views about side letters?

It provides the first empirical analysis of side letters by coding the terms of each side letter from a hand-collected sample spanning thirty years of buyout funds, testing common claims directly.

What reasons does the paper identify for why side letters are used and how they have changed over time?

The paper finds side letters mostly accommodate investors’ regulatory and tax concerns rather than reallocating fund economics. It also shows they have expanded in length and complexity, creating significant costs, negotiation delays, and contracting frictions over time.

Sep 16, 2026

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