Every investor asks for an MFN and most get one; its value is set by whose side letters it can elect from and what the exclusion list removes.
An MFN is worth the best side-letter term it can actually reach, multiplied by the fee base over the fund's life, less the share that carried interest takes back. On an illustrative 75 commitment, an MFN that reaches a 15 basis point fee discount is worth 0.84 of fees saved, or 0.67 after carry; the 0.84 is 1.12 per cent of the commitment. Add the usual two qualifications, eligibility limited to investors of equal or smaller size and first-close discounts excluded, and the same clause is worth nothing.
Worked in full in How to Read a Limited Partnership Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A most favoured nation clause lets an investor see the side letters granted to other investors and elect the terms it wants. Every investor asks for one, and most get one, so it rarely gets priced. The price is decided by three drafting choices: whose side letters the investor may elect from, which terms are excluded, and whether fee savings are measured before or after the waterfall. Each can take the value to zero.
| Item | Commitment | Term |
|---|---|---|
| Our investor | 75 | MFN, scope as drafted |
| Investor A | 200 | 25 bp fee discount, for size |
| Investor B | 100 | 10 bp fee discount, for size |
| Investor C | 50 | 15 bp fee discount, for coming in at first close |
The management fee is 2.0 per cent of commitments for a five-year investment period, then 1.5 per cent of the cost of unrealised investments. For our investor the post-period base runs 60.0, 50.0, 38.0, 25.0 and 12.0 in years 6 to 10. Carried interest is 20 per cent, and the fund is assumed to finish past its catch-up, with fees returned to investors before carry.
Fee base over the life = commitment × years of investment period + Σ post-period cost base
75 × 5 + (60.0 + 50.0 + 38.0 + 25.0 + 12.0) = 560.0 commitment-years. At the headline rates the investor pays 10.28 of fees, 13.70 per cent of its commitment.
An MFN does not reach every side letter. The standard limitation is by size: an investor may elect only terms given to investors whose commitments are equal to or smaller than its own. With 75 committed, A at 200 and B at 100 are out of reach, and only C at 50 qualifies. The standard exclusion list then removes terms granted for closing order, for regulatory or tax status, and for seats on the advisory committee. C's discount was given for coming in at first close, so it is excluded too.
Value = discount × fee base; value to the investor = value × (1 − carry rate)
15 bp × 560.0 = 0.84: 0.562 in the investment period and 0.278 after it. Fees saved are contributions not made, so the fund's profit rises by the same amount, and in a fund past its catch-up 20 per cent of that extra profit goes to the manager as carry: 0.168. The investor keeps 0.67.
| MFN scope | Discount reached | Fees saved | After carry | Fees saved, % of commitment |
|---|---|---|---|---|
| No MFN | 0 bp | 0.00 | 0.00 | 0.00% |
| Equal or smaller investors, first-close terms excluded | 0 bp | 0.00 | 0.00 | 0.00% |
| Equal or smaller investors, nothing excluded | 15 bp | 0.84 | 0.67 | 1.12% |
| All investors, nothing excluded | 25 bp | 1.40 | 1.12 | 1.87% |
The most common draft, the second row, gives the investor sight of everything and the right to elect nothing of fee value. That is not a defect in the clause: it is how the clause is meant to work, protecting the manager's ability to pay for size and for early commitment. An investor that wants an MFN with economic content has to negotiate the exclusion list, not the headline.
| Commitment | Fees saved | After carry |
|---|---|---|
| 25 | 0.28 | 0.22 |
| 50 | 0.56 | 0.45 |
| 75 | 0.84 | 0.67 |
| 150 | 1.68 | 1.34 |
| 300 | 3.36 | 2.69 |
The value scales with the commitment, but the reach does not: a larger investor clears more of the size tiers, so the realistic discount rises with size too. If the fund never reaches its catch-up, carry takes nothing and the investor keeps the whole saving, which is exactly when the saving matters most.
Reading the side letter pack. When the MFN disclosure arrives, tabulate every term by the commitment of the investor that received it and the reason it was given. Strike out what lies above your size and what falls in an excluded category. What remains is what your MFN is worth; for many investors it is a reporting template and a confidentiality carve-out.
Valuing a fee discount as if it went straight to the investor. A 15 bp saving on this commitment is 0.84 of fees, 8.2 per cent of the total fee bill, but fees are returned before carry, so a fund that performs keeps a fifth of every fee saving through the waterfall. The same logic runs in reverse in whether carried interest comes after investors get their fees back, and the full fee bill over a fund's life is worked in how much a 2 per cent management fee costs.
Price an MFN on the terms it reaches, not on the terms it shows. Here the investor's clause reaches 15 bp only if first-close terms are not excluded, and then saves 0.84 of fees, 0.67 after carry. The working documents for the book include a page that tabulates the side letter pack term by term, which is where this calculation starts.
Terms granted for size above the electing investor's commitment, for closing order, for regulatory or tax status, and for advisory committee seats. In the illustrative case a 75 investor could see a 25 bp, a 10 bp and a 15 bp discount, but the first two were for larger investors and the third for a first close, so it could elect none.
Not in a fund past its catch-up. Fees are returned before carry, so saving fees raises profit and 20 per cent of the saving goes to the manager. A 15 bp discount on an illustrative 75 commitment saves 0.84 of fees and leaves the investor 0.67.
Multiply the discount by the sum of each year's fee base. For an illustrative 75 commitment with a five-year investment period and post-period cost bases of 60.0 to 12.0, the base totals 560.0 commitment-years, so 15 bp is worth 0.84 and 25 bp is worth 1.40.
This article is one calculation from How to Read a Limited Partnership Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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