What is a side letter in a funding round?
By SuLe · Updated 20 May 2026
A side letter is a private contract between your company and one investor, granting that investor extra rights alongside the main funding round documents — commonly information rights, pro-rata rights, a most-favoured-nation clause or a board observer seat. It binds like any contract, but it sits outside the shareholders' agreement and articles, which is both its convenience and its risk.
Key facts
- A side letter is a binding contract, even though it sits outside the main round documents.
- Commonly requested extras: information rights, pro-rata rights, an MFN clause or a board observer seat.
- An MFN ("most favoured nation") clause hands its holder any better terms you later give another investor.
- Rights attached to a class of shares belong in the articles of association — public at Companies House — not in a private letter.
What does a side letter actually do?
It gives one investor a personal deal on top of the round's shared terms. The main documents — subscription agreement, shareholders' agreement, articles — apply to every investor alike; the side letter grants extras to its named investor alone.
Commonly those extras are information rights, a right to invest pro-rata in future rounds, a most-favoured-nation clause or a board observer seat.
Investors typically ask for one when they need something specific to them — reporting their own backers require, say — without reopening the whole negotiation for everyone. That is the legitimate use: a narrow personal add-on, documented cleanly.
What terms commonly appear — and what do they mean?
Information rights entitle the investor to regular management accounts or KPI updates beyond what shareholders receive by default. Pro-rata rights let them invest enough in the next round to maintain their percentage. A board observer attends board meetings without a vote.
The MFN clause deserves its own paragraph. "Most favoured nation" means that if you later give any investor better terms, this investor automatically inherits them — a one-way ratchet that compounds across every side letter you sign afterwards.
None of these asks is inherently unreasonable; the problem is aggregation. One investor's monthly reporting pack is fine. Five investors' five different reporting packs is an operations tax on a two-founder company.
Is a side letter binding — and can it override the main documents?
It is a normal contract: binding and enforceable, with damages or other remedies for breach. What it cannot cleanly do is rewrite rights that live elsewhere.
Rights attaching to a class of shares sit in your articles of association — a public document filed at Companies House under the Companies Act 2006, binding on all shareholders. A private letter with one investor cannot quietly amend the articles, and it cannot bind shareholders who never signed it.
Well-drafted side letters therefore include a priority (conflict) clause stating which document wins if the letter collides with the shareholders' agreement. Without one, you have pre-purchased an argument.
What are the risks of handing out side letters?
Aggregation and forgetfulness. Each letter looks small; a drawer of them amounts to a shadow constitution that nobody is tracking — until your next lead's due diligence surfaces every one and asks why four investors hold MFN rights.
So assume disclosure. Side letters typically surface in due diligence at the next round, and MFN holders are entitled to anything better you granted in the meantime. Draft nothing you could not comfortably show your next lead investor.
And keep a register: who holds which right, granted when, ending when. Future-you, negotiating a Series A, will be grateful for the list.
| Common side letter term | What the investor gets | Watch out for |
|---|---|---|
| Information rights | Regular management accounts or KPIs | Multiple bespoke reporting packs across investors |
| Pro-rata right | Room to maintain their stake next round | Stacked pro-ratas squeezing the next lead's allocation |
| MFN clause | Any better terms you later grant anyone else | One concession propagating to every MFN holder |
| Board observer | A seat in the room, without a vote | Confidentiality and board dynamics |
Worked example
Tomas and Grace, founders of a fintech infrastructure startup, close a £750,000 seed round. Their lead investor, in for £400,000, signs a side letter: monthly management accounts, a board observer seat, a pro-rata right for the next round and an MFN clause.
Eight months later a strategic angel invests £50,000 and negotiates a wider pro-rata right. The MFN clause does its work: the lead automatically inherits the wider right too. Because Tomas and Grace kept a side letter register and put a priority clause in each letter, their Series A due diligence eight months after that is painless — every right is visible and consistent, and several are terminated by agreement at completion of the new round.
Where founders go wrong
Granting an MFN without tracking it
— every concession you make in a later side letter can flow back to the MFN holder. Keep a register of who holds what.Putting share rights in a side letter
— class rights belong in the articles; a private letter cannot bind other shareholders and unravels under due diligence.Contradicting the shareholders' agreement
— conflicting documents mean an argument at the worst possible moment. Add a priority clause saying which document wins.Assuming side letters stay secret
— the next round's due diligence will surface them all. Sign nothing you could not show your future lead.
Related questions
Is a side letter legally binding?
Yes — it is an ordinary contract between the company and the investor, enforceable like any other. Its informal name misleads founders: "letter" describes the format, not the force. Breach it and the investor has contractual remedies, so track every obligation you have signed up to.
Do other investors get to see our side letters?
Expect them to. Due diligence at your next round typically surfaces every side letter, and any investor holding an MFN clause is entitled to better terms you granted later. The working assumption: anything you sign privately will eventually be read by every future lead.
What is an MFN clause in a side letter?
"Most favoured nation": if the company later gives another investor more favourable terms, the MFN holder automatically receives them too. It protects early investors from being leapfrogged — and it means every future concession you make is potentially multiplied across all MFN holders. [More: What are pro-rata rights?]
Can a side letter change the rights attached to shares?
No — rights attaching to a class of shares belong in the articles of association, which bind all shareholders and are public at Companies House. A side letter grants personal, contractual extras to one investor; it cannot quietly rewrite the rights everyone else relies on.
Side letters look harmless one at a time — the damage comes from what they add up to, and from clauses like MFN that quietly multiply every future concession. A SuLe solicitor can review a requested side letter against your existing documents before you sign it. Book a free term sheet review and find out what that "quick letter" really commits you to.
Keep reading: What is a term sheet — and is it legally binding? · What should a UK seed-stage term sheet include? · What is a subscription (investment) agreement? · What is a priced round vs a convertible round? · What are information rights? · What are pro-rata rights?
Primary sources: Companies Act 2006
