F1: ORGANIZATIONAL STRUCTURE OF AN MLP
Sponsor Common Units
The General Partner
[Incentive Distribution Rights]
0% General Partner
formation considerations designed to support the underlying objectives of the MLP.
It is important to understand that MLPs
are flexible and should be structured
around the specific cash flow characteristics of MLP assets. If we have learned anything from the latest down cycle, it is that
we should endeavor to structure MLPs to
withstand even the harshest price
MLPs are publicly traded limited partnerships that are listed on a national securities
exchange – typically, the NYSE or Nasdaq.
Similar to stock in a corporation, interests
in MLPs (referred to as “units”) are bought
and sold in public offerings and over the
counter through ordinary brokerage transactions, similar to stock in a corporation.
The primary objective is to structure
and form a tax efficient investment vehicle
that generates sufficient current cash flows
to pay distributions to unitholders, has low
capital expenditure requirements to grow
its asset base, and has significant long-term
growth opportunities to increase cash distributions to unitholders over time.
Designing an MLP that achieves the
objectives of the sponsor and meets the
expectations of investors requires a detailed
analysis of the MLP’s expected cash flows.
It is critical that the MLP’s stated cash distribution policy reflects the projected cash
flow profile of MLP. For example, midstream
companies that are supported by long-term, fee-based contracts typically generate
stable cash flows and, therefore, are suitable
for a distribution policy that pays a minimum quarterly distribution. On the other
hand, companies with significant unhedged
commodity price exposure are not good
candidates for a minimum quarterly distribution policy – rather, a more appropriate distribution policy would be variable
Recognizing that there are material,
sometimes subtle variations in asset characteristics, cash flow volatility, and the
perceived ability to mitigate cash flow volatility over the long term are prerequisites
to selecting an appropriate MLP
Organizational structure of an MLP
The basic organizational structure of a MLP involves two tiers, with the MLP being a
limited partnership whose sole asset is the ownership of all of the membership interests
in a limited liability company or all of the partnership interests in another limited partnership that owns and operates the assets of the operating business (See Figure 1).
The general partner of the MLP typically owns a non-economic interest in the MLP,
and may own rights to increasing portions of cash distributed by the MLP, which are referred to as “incentive distribution rights.” The limited partnership interests in the MLP
are allocated between the sponsor of the MLP and the public investors.
The two-tier structure is based upon the desire for operational, legal, tax, and financial
flexibility. For instance, the two-tier structure allows a MLP to effect “double breasted”
financing – debt financing at the subsidiary level and debt financing at the MLP, which is
structurally subordinated to subsidiary level debt. Additionally, the two-tier structure
enables the MLP to segregate assets and debt among multiple subsidiaries for operational
accountability, liability, regulatory, tax, or various other reasons.
Economic structure of an MLP
Cash distribution policy – The economic structure of an MLP is centered around cash
flow and the expectation of cash distributions. Under the terms of the partnership agreement, an MLP is required to distribute all “available cash” to its unitholders, quarterly or
• Minimum quarterly ddistributions – Businesses that generate stable and consistent
cash flow from quarter-to-quarter are able to commit to paying a “minimum quarterly
distribution” to unitholders. In the offering documents, the MLP makes a statement as
to its “intention” to distribute a specific minimum quarterly distribution on each outstanding unit. This stated intention is the basis for the “yield” at which the MLP is
marketed to investors. When the MLP intends to pay a minimum quarterly distribution
to its unitholders, the sponsor will retain a portion of its equity in “subordinated units”
to support the distribution on the common units. In exchange, the sponsor will receive
incentive distribution rights.
• Variable distribution MLPs – Businesses that do not generate stable or consistent cash