Investor Side Letters: What They Cover and When to Use Them
You're just about to close your funding round. The shareholders' agreement is agreed, and the cap table is updated. Then your lead investor's solicitor sends over a separate document requesting additional terms that are not in the main deal paperwork. This is a side letter, and if you are raising investment for an Irish startup, you may have encounter one.
This article explains what investor side letters are, what terms they typically contain, when they are appropriate, and how Irish founders can negotiate them without creating problems for future rounds.
What is a side letter?
A side letter is a separate agreement between a company and an individual investor that documents specific terms outside the main investment documents. It sits alongside the shareholders' agreement and subscription agreement , for whatever reason, such as granting that investor rights or obligations that do not apply to the other shareholders.
The parties may request side letters rather than amending the main documents for a practical reason: changing the shareholders' agreement requires signatures or consent from multiple parties, which is slow and complex. A side letter lets one investor, or a number of investors, secure specific provisions without reopening the entire deal.
Side letter terms may be confidential between the company and the requesting investor. Other shareholders may not know what has been agreed unless disclosure is required, the terms may need to be disclosed during due diligence for a future round.
What terms do side letters typically cover?
The specific terms vary depending on the investor, their fund mandate, and the stage of the round. But certain provisions appear consistently across startup side letters.
Enhanced information rights go beyond what the shareholders' agreement provides. An investor may request monthly management accounts , quarterly board packs, or early notification of material events. These rights give the investor greater visibility into the company's performance than other shareholders receive.
Board observer rights allow the investor to attend board meetings without having a formal board seat . The observer can listen, ask questions, and receive board materials, but cannot vote. This is common for investors whose commitment size does not justify a full directorship.
Pro-rata rights on future rounds guarantee the investor can participate in subsequent funding rounds to maintain their ownership percentage. While pro-rata rights are often included in the main shareholders' agreement, a side letter may extend or strengthen them.
Most favoured nation (MFN) clauses entitle the investor to receive any more favourable terms that the company grants to other investors in the same or future rounds. If another investor negotiates a lower valuation cap or better information rights, the MFN holder can elect to adopt those terms.
Author's tip: MFN clauses sound reasonable in isolation, but they can cascade. If Investor A has an MFN and you grant Investor B a better discount, Investor A can claim the same discount. If Investor C then has an MFN referencing Investor A's updated terms, the effect compounds. Always model the worst-case scenario before agreeing to an MFN.
Co-investment rights allow the investor's affiliated funds or partners to invest alongside them, sometimes on preferential terms.
When are side letters appropriate?
Side letters are not inherently problematic. In many situations, they are a practical solution to genuine investor-specific requirements.
A lead investor making a substantially larger commitment than other participants may reasonably expect governance provisions that reflect their exposure. Board observer rights and enhanced reporting are standard requests from lead investors who are actively supporting the company.
Regulatory or fund mandate requirements sometimes drive side letter requests. An investor's fund documents may require specific reporting formats, ESG disclosures, or compliance certifications that are irrelevant to other shareholders but mandatory for that fund.
Individual investor circumstances, such as tax residency requirements or specific reporting obligations, can also justify side letter provisions. These are administrative rather than commercial, and are usually straightforward to accommodate.
The general principle is that a side letter is appropriate when the main investment documents cannot easily accommodate one investor's specific needs without affecting all other shareholders.
What are the risks and complications for founders?
Side letters create risks that are easy to underestimate at the time of signing but can surface at the worst possible moment, typically during your next fundraise.
Conflicting obligations across multiple side letters are the most common problem. If you have granted different investors different information rights, reporting timelines, or consent requirements, you may find yourself managing a patchwork of bespoke obligations that are difficult to track and easy to breach.
MFN cascades can trigger unintended consequences. When multiple investors hold MFN rights, granting better terms to any single investor can ripple across all MFN holders. The cumulative effect may be far more generous than you intended when you agreed to the original terms.
Administrative burden increases with each side letter. Every bespoke obligation needs to be tracked, fulfilled on schedule, and documented. For a small founding team, this overhead is real.
In practice, this means: Before your Series A, the incoming investor's lawyers will ask for copies of all existing side letters during due diligence. Undisclosed side letters discovered at this stage can derail a round or lead to renegotiation of terms. Keep a register of all side letter obligations from day one.
Due diligence exposure is the risk that catches founders off guard. Future investors will want to see every side letter, and any term sheet that look unusual or overly generous will raise questions about the company's negotiating discipline.
What are the legal considerations under Irish law?
Irish company law does not specifically regulate side letters, but several legal principles apply.
The company's constitution takes precedence over any side letter. If a side letter grants rights that conflict with the company's articles of association, the constitutional provisions will generally prevail. Before signing a side letter, check that its terms are consistent with the constitution.
Directors owe fiduciary duties under the Companies Act 2014 . When agreeing to side letter obligations on behalf of the company, directors must act in good faith in the interests of the company as a whole, not just to satisfy one investor's demands. Agreeing to terms that benefit one shareholder at the expense of others could expose directors to liability.
Enforceability becomes complicated when a side letter conflicts with the shareholders' agreement. Irish courts will look at the specific wording and the parties' intentions, but the general position is that where the SHA and a side letter are inconsistent, the SHA will usually take priority unless the side letter explicitly states otherwise.
Disclosure obligations in subsequent fundraising rounds mean that side letters are rarely as confidential as founders assume. New investors' solicitors will request full disclosure as part of standard due diligence, and warranties in the new investment agreement will typically require you to confirm that all material agreements have been disclosed.
How should founders negotiate side letters?
The goal is to accommodate reasonable investor requests without creating obligations that complicate future rounds or burden the company.
Limit scope and duration. Every side letter provision should have a clear boundary. Information rights should specify what is provided and how often. Board observer rights should be tied to the investor maintaining a minimum shareholding. Avoid open-ended commitments.
Include sunset clauses. Side letter provisions should expire or be reviewable at defined trigger points, such as the next priced round, a change of control, or a specified date. This prevents legacy obligations from accumulating indefinitely.
Require disclosure to co-investors. If you agree to an MFN, consider requiring that the terms of each side letter be disclosed to all MFN holders at the close of the round. This reduces the risk of surprises later and encourages investors to keep their requests reasonable.
Push back where appropriate. Not every request needs to be granted. If an investor asks for terms that would properly belong in the shareholders' agreement, insist that they go there. Side letters should handle genuinely investor-specific matters, not rewrite the deal terms for one party.
Reviewing side letter terms for your next round?
Side letters are a normal part of fundraising, but the details matter. Open Forest can help you review incoming side letter requests, flag potential conflicts, and keep your obligations manageable.
Keep a side letter register. Maintain a central record of every side letter, its key provisions, expiry dates, and compliance requirements. This saves hours of scrambling when your next investor's lawyers request full disclosure.
Where this leaves you
Side letters are a standard feature of startup investment rounds, and encountering them is not a cause for concern. The risk lies in agreeing to terms you do not fully understand, failing to track your obligations, or creating conflicts that surface during future due diligence.
Approach each side letter with the same care you would apply to the main investment documents. Limit scope, set expiry dates, and keep a clear record. If you are navigating side letter negotiations for the first time, Open Forest can help you understand what is standard, what is aggressive, and where to draw the line.
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