Side Letter Guide: Meaning, Use Cases, Legal Validity, and Common Clauses

What is a side letter?

A side letter is a separate agreement that supplements, clarifies, or modifies specific terms of a main contract between a company and a particular investor or shareholder.

It exists alongside a principal agreement, such as:

• a Shareholders’ Agreement (SHA);
• a Share Subscription Agreement (SSA); or
• a Limited Partnership Agreement (LPA).

A side letter grants rights, waivers, or obligations that are not included in the main agreement and applies only to the parties who sign it.

Although it sits outside the core documents, a side letter can be just as legally binding as the main agreement if it is properly drafted and executed.

Why do founders and investors use side letters?

Side letters are used to accommodate specific requests without reopening or amending the main transaction documents.

From a founder’s perspective, side letters are often a pragmatic tool. Rather than amending the SHA to address an individual investor request, which can trigger re-circulation, re-approval, or additional consents, a side letter allows founders to address reasonable asks while keeping the core documents unchanged.

Common reasons for using side letters include:

• closing a deal faster without renegotiating agreed documents;
• granting one investor additional rights, such as enhanced reporting or future participation rights;
• meeting regulatory, tax, or internal policy requirements of a specific investor; and
• waiving or relaxing certain standard provisions for a particular investor.

For example: A company adopts a SHA for all investors. A large institutional investor requires quarterly MIS reporting in a specific format to meet its internal governance requirements. Instead of amending the SHA for all shareholders, the company documents this obligation through a side letter that applies only to that investor.

Is a side letter legally binding in India?

A side letter can be legally binding in India, but it operates within a clear hierarchy.

First, it cannot override statutory law. If a side letter conflicts with the Companies Act, 2013, or with the company’s Articles of Association, it may be unenforceable.

Second, it must qualify as a valid contract under Indian law. This requires:

• clear agreement between the parties;
• lawful consideration;
• a legitimate purpose; and
• proper authority from each signatory.

Informal emails or loosely drafted side arrangements are far more likely to be challenged or ignored in a dispute.

Common side letter clauses

1. Participation and pro rata rights

Participation rights give an investor the right to invest in future funding rounds.

These rights are usually exercised on a pro rata basis, meaning the investor can invest only enough to maintain its existing ownership percentage.

2. Information and reporting rights

Some investors request more frequent or more detailed financial, operational, or compliance reporting than other shareholders receive.

While these requests are often driven by internal governance or regulatory needs, they create ongoing operational obligations for the company. If they are not clearly scoped, they can become burdensome as the company scales.

3. Board observer or consultation rights

These clauses allow an investor to attend board meetings as an observer or to consult with management on specific matters, without holding a formal board seat.

While they can add strategic value, poorly drafted observer rights can blur the line between observation and control.

4. Waivers to standard SHA provisions

Side letters are sometimes used to waive or soften standard obligations under the SHA such as drag-along rights, Rights Of First Refusal (ROFR), or lock-in periods.

These waivers can complicate future exits or secondary transactions if they are not tightly drafted.

Example:
An early investor requests a side letter stating that they are not bound by a drag-along clause if an exit occurs below a certain valuation. While this may seem reasonable early on, it can later delay or derail an acquisition if a buyer expects all shareholders to sell on the same terms.

Side letter vs addendum: what’s the difference?

A side letter is a separate agreement that applies only to specific parties, while an addendum formally amends the main agreement and applies to all parties to that agreement.

In VC fundraises, founders typically prefer side letters when:

• Only one investor is asking for a specific right
• The core SHA has already been negotiated and signed
• The change should not apply to all shareholders

An addendum, on the other hand, is used when the underlying agreement itself needs to be modified for everyone.