Side letters are a hot topic in the private markets, and for good reason. The volume and complexity of side letters have grown dramatically in the past decade. In fact, the average number of terms in a side letter grew from 3 to 31.7 between 2005 and 2014.
Managers are also encountering increased regulatory scrutiny, with a particular focus on side letters. Chair Gary Gensler of the U.S. Securities and Exchange Commission specifically addressed side letters in his 2021 remarks to the Institutional Limited Partners Association Summit. Then, in early 2022, the SEC proposed regulations that would impact when and how managers could enter into side letters involving preferential terms for particular investors.
While firms await the final version of the proposed SEC rule, they must address how best to navigate complex side letter terms and meet all their investor obligations.
Weaknesses in traditional side letter management
Managers have traditionally relied on massive compendia that take months to build and become out of date quickly to manage their investor obligations. In a survey by Ontra and Wakefield Research, 43% of asset managers said it took four to six months to get a compendium of key fund documents and side letter terms. During that time, firms might not be aware of all their obligations and face a significant risk of noncompliance.
Once managers receive a compendium, months after closing a fund, they can finally start identifying their obligations to investors and assigning related tasks to internal stakeholders. The challenge is that most firms lack a digital way to identify, assign, and complete these tasks.
With traditional processes, it’s difficult for fund managers to identity particular provisions and obligations across a fund, let alone multiple funds. Once they find the information they need, they have to separately and manually review their contracts and, in many cases, consult with outside counsel about what the firm has agreed to.
To comply with their obligations, stakeholders often string together spreadsheets, calendar reminders, emails, tabbed binders, and even Post-it notes. Unsurprisingly, Ontra found 77% of our survey respondents worried at least once in the past year about failing to comply with investor obligations. Failing to deliver on an investor obligation could result in costly and time-consuming remedial work, damaged relationships, regulatory penalties, and front-page headlines.
Ontra built Insight, a centralized platform that digitally transforms firms’ contract management processes, to tackle these issues. Insight provides managers with a single source of truth for their side letters. Within the platform, internal stakeholders have immediate access to their contract data and can proactively manage investor obligations by assigning and tracking internal compliance with tasks.
Ontra’s AI-enabled contract management technology
A central repository
With Insight, firms gain a centralized repository of all their contracts and documents across funds, with their obligations accurately summarized and categorized for easy access. Ontra’s AI-enabled software extracts, digitizes, and categorizes contract commitments. Through a blend of machine learning and a network of experienced industry lawyers, firms transform their fund documentation into structured data.
Insight’s SmartSearch feature gives stakeholders immediate, reliable search results. Professionals can search summaries and actual contract language and review results that Ontra’s proprietary algorithm ranks by relevance. As a result, firms can rely less on outside counsel and instead quickly answer questions internally.
Multi-stakeholder obligation workflows
Insight provides multi-stakeholder obligation workflow tools through which firms can assign tasks and subtasks, monitor stakeholders’ actions, and report on their contract compliance efforts. Stakeholders can designate ownership of one-off and repeatable tasks as well as set alerts to notify owners when tasks are due.
The results of this feature are immediate and enhanced visibility into investor obligations, repeatable processes that can scale with the firm, improved accountability, and a lower risk of noncompliance.
In-house professionals can use the SmartLine redlining feature to compare unlimited provisions to a designated base provision. They can group similar terms together in SmartGroups while also quickly identifying key differences in similar contract terms.
This feature also enables firms to analyze precedent terms to gauge consistency across contracts and identify off-market positions.
Data analytics and reporting
Firms can quickly search, review, and report on their contract data. By running reports, stakeholders can visualize contract trends across all or portions of their agreements to inform future negotiations and make data-driven business decisions.
Improved compliance and investor relations
Asset managers often take pride in their operating expertise and ability to avoid compliance pitfalls. But traditional side letter management tends to place considerable risk and stress on in-house deal, legal, and compliance professionals’ shoulders.
There is a better way, one in which firms streamline their compliance workflows, mitigate risk, and give themselves room to focus on the strategic initiatives that benefit themselves and their investors. With Insight, internal stakeholders can spend less time reacting to obligation management tasks and more time focusing on fundraising and investing.
Ultimately, firms gain a competitive advantage in the private markets by improving compliance with investor obligations, reducing exposure to regulatory penalties, and creating space to focus on returns.