A master limited partnership is a specific type of business set-up. It is a limited partnership whose shares are publicly traded. This set-up is only allowed in specific areas of industry.
A standard limited partnership exists to limit the liability of the partners, the people who jointly own the business. It differs from a corporation in that the business is not a separate legal entity and thus the owners are responsible for any debts. With this set-up, though, this liability is limited to the value of each partner's ownership in the business. In effect, this means they cannot lose more than the money they put into the business.
The key difference with a master limited partnership is that shares in the business are publicly traded. This means that they are listed on a securities exchange, usually a stock market. This can be a major advantage for the business as it makes it much easier to raise capital by selling off ownership.
Another benefit of a master limited partnership is that it is not classed as a corporation for tax purposes in the United States. This means it will not have to pay corporate income taxes, either federally or to a state. This avoids the dual-taxation situation with most corporations where the company pays taxes on its profits and then the stockholders pay taxes on dividends.
Strictly speaking, the ownership stake owned by each partner is not in the form of shares. Instead it is known as a unit, with owners known as unit holders. Payments from profits are known as distributions rather than dividends. There is also a distinction between general partners, who run the business from day to day, and limited partners, who are simply investors in the company.
When it comes to distributing profits, most master limited partnerships work on a model that is not common in other business set-ups. Usually the general partners will only own a small proportion of the business, often 2%. This means that of the first dollar paid in distributions, two cents will go to the general partners and 98 cents to the limited partners, just as with dividends in a corporation. There is usually then a sliding scale, meaning that the larger the total amount paid in distributions, the bigger the proportion which goes to the operating partners. In some cases, the operating partners may get as much as half of the distributions.
Not all businesses are allowed to be set up as a master limited partnership. US law restricts it to specific industries. As a rough rule of thumb, a business must get at least 90% of its revenue from commodities, real estate or natural resources to qualify.
