The challenging capital raising environment has generally tilted the typical balance of power in favor of institutional investors. As a consequence, with increasing frequency, institutional investors are requesting side letters
from hedge funds or their managers. Side letters typically grant the requesting investor preferential rights that are not granted to other investors in the fund’s governing documents; these preferential rights can include special fee reductions
, transparency rights
, redemption rights
, capacity rights
, etc. Additionally, side letter requests now regularly include so-called “Most Favored Nation” (MFN) provisions – which are used by investors to ensure that any rights granted to current or future investors are also offered to the requesting investor. Requesting investors often demand broad protections in MFN provisions, arguing that they cannot anticipate what rights will be granted to future investors. While it may be convenient for hedge fund managers to dismiss MFN provisions as “standard” requests from investors, MFN provisions can present numerous pitfalls for fund managers if they are not properly evaluated, appropriately negotiated and effectively monitored to ensure compliance. This article provides a roadmap for understanding MFN provisions and their implications for a manager’s business, operations and compliance processes. Specifically, this article describes: the anatomy of an MFN provision; the key terms of an MFN provision; the three principal concerns raised by the use of MFN provisions; and eight recommendations for drafting and administering MFN provisions to mitigate key concerns.