Private Equity Side Letters

For those of you who don't read "The Deal" or subscribe to it online, I recommend it as it provides the inside scoop on the world of private equity. Today's Deal has posted an article about Private Equity Side Letters. For those who do not subscribe and cannot follow the link, a private equity side letter is a letter written by a GP to a special LP outlining the special deal or agreement between the two. This letter usually goes to a handful of LPs that the GP wants to specially favor because the LP is a notable investor, the largest investor, or someone with deep connections that adds value to the fund other than money. Typically, a side letter is not that big of a deal because the Partnership Agreement usually already states that the GP may waive fees or carry at its discretion. That is usually understood to affect the loyal investors and friends of GPs, and that other LPs should not worry about it.

Apparently, hedge funds entry into private equity has brought this under the eye of the SEC who plan to look into this matter. The concern is that other LPs may be at disfavor due to a conflict between the favored and non-favored LP. I have touched on this concept of conflicts of interest before. Anyways, it will be interesting to see how this all shakes out. My personal opinion is that side letters are part of the private equity business and in some form or another they will always be around. By its nature, private equity is not an equal playing field and all investors are not treated equally. The reciprocal nature of deal flow syndication and cross-investment in various GPs is almost standard of practice. It will be difficult to regulate a business that thrives on privacy and non-regulation. Hopefully, increased scrutiny will improve the industry rather than detract from it by the creation of more cumbersome regulations like Sarbanes-Oxley.

As always, you comments and thoughts are welcomed.