Most Favored Nation (MFN) provisions have become a standard feature in private fund agreements. At their core, MFN clauses allow an investor to elect rights granted to other investors through side letters, ensuring that no investor is arbitrarily disadvantaged. This mechanism promotes fairness and transparency, but it also introduces complexity for fund sponsors who must balance investor demands with operational feasibility.
Why MFN Matters
Side letters are now ubiquitous in private equity and alternative funds, often granting bespoke rights to investors, such as reporting accommodations, fee discounts, or governance privileges. Without MFN provisions, these rights could create a perception of unequal treatment. MFN clauses level the playing field by allowing eligible investors to “opt in” to certain terms negotiated by others.
However, unrestricted MFN elections can lead to a “free-for-all,” where smaller investors gain access to rights intended for cornerstone or strategic investors. To prevent this, sponsors implement tiered access structures.
Tiered Access: The Practical Solution
Tiering links MFN election rights to an investor’s commitment size or status. For example:
Large Investors (e.g., first-close or anchor investors) may access all side letter terms.
Mid-Tier Investors may elect provisions related to reporting or governance but not fee discounts.
Smaller Investors may be limited to operational or compliance-related provisions.
This approach preserves the commercial incentives for early or large commitments while maintaining fairness among similarly situated investors.
Common Carve-Outs
Sponsors often exclude certain provisions from MFN elections entirely, such as:
LPAC Appointment Rights – Reserved for significant investors.
Jurisdiction-Specific Compliance Terms – E.g., reporting obligations for regulated investors.
Fee Discounts – Typically tied to ticket size or early support.
Operational and Compliance Challenges
Managing MFN elections is resource-intensive. Sponsors must:
Track and disclose eligible provisions.
Administer election windows (often shortly after closing).
Ensure ongoing compliance with elected rights.
Without clear carve-outs and standardized language, MFN processes can create a “cottage industry” of compliance obligations, especially in open-ended funds where elections recur after each closing.
AI in MFN Administration
Artificial intelligence can streamline MFN management by:
Automating Side Letter Analysis – AI tools can extract and categorize provisions for easier disclosure.
Tiering Logic Engines – Systems can apply commitment-based rules to determine eligibility.
Compliance Monitoring – AI can flag conflicts or overlapping rights across investors.
These tools reduce manual effort, minimize errors, and allow sponsors to focus on strategic investor relations rather than administrative burdens.
Key Takeaways
MFN provisions promote fairness but require careful structuring.
Tiered access preserves incentives for large or early investors while maintaining equity.
AI-driven solutions can significantly reduce the complexity and cost of MFN administration.