UP-C Initial Public Offering Structures: Overview, Practical Law Practice Note w-009-1403

UP-C Initial Public Offering Structures: Overview
by Joshua Ford Bonnie, William R. Golden, and Andrew B. Purcell, Simpson Thacher & Bartlett LLP, with Practical Law Corporate& Securities

Law stated as of 20 May 2024 • USA (National/Federal)

This Practice Note provides an overview of the Umbrella Partnership – C-corporation (UP-C) initialpublic offering (IPO) structure and selected related legal and tax considerations. By implementing an
UP-C structure instead of more traditional IPO structures and entering into tax receivable agreements,
pre-IPO owners of businesses taxed as partnerships can receive substantial post-IPO tax benefits.

Basic Features and Implementation of the UP-C IPO Structure
UP-C IPO Mechanics
Exchanging OP Units for Pubco Shares
Governance and Voting
UP-C Organizational Structure Chart

Exchange Rights and Liquidity
Tax Benefits
Operating Income
Capital Gains on Exit or Other Asset Sales
Tax Receivable Agreement

Distributions and Dividend Policy
Maintaining Parity between OP Units and Pubco Shares
Certain Considerations

For businesses taxed as partnerships that are considering an initial public offering (IPO), the Umbrella Partnership –C-corporation (UP-C) structure can offer pre-IPO owners the liquidity and other benefits of a public listing in a more taxefficient manner than the traditional alternative of converting into a C-corporation at the time of an IPO.
For information on the taxation of partnerships, see Practice Note, Taxation of Partnerships. For a list of resources on IPOs
more generally, see the Initial Public Offerings Toolkit. For information on the UPREIT structure (which was a precursor to
the UP-C structure), see REITs: Overview.

© 2024 Thomson Reuters. No claim to original U.S. Government Works.

1

UP-C Initial Public Offering Structures: Overview, Practical Law Practice Note w-009-1403

Basic Features and Implementation of the UP-C IPO Structure
The UP-C structure is a two-tiered structure involving one entity taxed as a partnership and another entity taxed as acorporation, in which:•

The pass-through entity (commonly referred to as the operating partnership or OP) holds all of the assets
and operations of a business. The pass-through entity may be organized in any legal form that is taxable as apartnership under US tax laws, but it is most often organized as either:••a limited partnership (LP); or•a limited liability company (LLC).

The pre-IPO owners continue to hold their interests directly in the pass-through OP and, accordingly, their share of
the income of the business is not subject to an entity-level tax.

•

Public investors hold their interest in the OP indirectly through an entity (the Pubco) organized as a corporation orother legal form taxable as a C-corporation.

The UP-C structure is frequently implemented through a reorganization at the time of the IPO:•

Most often, by modifying the capital structure of an existing tax partnership to reclassify the interests held by the
pre-IPO owners into a single new class of common equity interests in the OP typically referred to as OP Units.

•

Where the existing business has historically been held through multiple entities, by undertaking a roll-up transaction
where the pre-IPO owners contribute their interests in the business to a newly formed OP in exchange for newly
issued OP Units.

Counsel must carefully consider the design and implementation of each reorganization to address the particular commercial
and tax objectives of the company's owners and the facts and circumstances of the transaction.

UP-C IPO Mechanics
To effect the IPO, a newly formed Pubco offers shares (Pubco Shares) to the public and uses the cash proceeds from theoffering to acquire a number of OP Units in the OP equal to the number of Pubco Shares sold in the offering. In a primaryoffering, the cash proceeds are invested by the Pubco directly in the OP in exchange for newly issued OP Units. If there
is a secondary component, all or a portion of the cash proceeds may be used by the Pubco to acquire outstanding OP
Units from the pre-IPO owners. The Pubco always holds a number of OP Units in the OP equal to the number of Pubco
Shares it has issued and outstanding. Therefore, each Pubco Share represents the same proportional interest in theunderlying business as, and is economically equivalent to, an OP Unit (see Maintaining Parity between OP Units andPubco Shares).

© 2024 Thomson Reuters. No claim to original U.S. Government Works.

2

UP-C Initial Public Offering Structures: Overview, Practical Law Practice Note w-009-1403

Exchanging OP Units for Pubco Shares
To provide the holders of OP Units with liquidity, OP Units held by persons other than the Pubco (OP Unitholders) are typicallyexchangeable at the option of the OP Unitholder for Pubco Shares on a one-for-one basis, subject to customary conversion
rate adjustments for stock splits, stock dividends, and reclassifications. Certain UP-C structures provide that the Pubco or
the OP may elect to deliver the cash value of the Pubco Shares otherwise deliverable in exchange for the OP Units basedon the market price of the Pubco Shares. These arrangements are typically documented in an exchange agreement or in
the limited partnership agreement or limited liability company agreement of the OP.

Governance and Voting
The Pubco controls the OP, typically by serving as its general partner or managing member. It is common in an UP-C
structure for OP Unitholders to also hold a separate class of non-economic, voting securities in the Pubco that afford themwith voting power in the Pubco. Often, these voting securities are designed to provide the OP Unitholders with voting powerin the Pubco that is commensurate with the voting power they would receive if their OP Units were fully exchanged for Pubco
Shares, although high vote/low vote structures are sometimes implemented. As OP Units are exchanged for Pubco Shares,
the voting power in the Pubco afforded to OP Unitholders is typically correspondingly reduced. While the exact mechanics
vary, this may be accomplished in several ways, including:•

The redemption by the Pubco of an exchanging OP Unitholder's non-economic, voting securities of the Pubco at thetime the holder's OP Units are exchanged for Pubco Shares.

•

The concurrent surrender or exchange by the OP Unitholder of non-economic, voting securities of the Pubco
together with the OP Units.

•

A formulaic reduction in the voting power afforded the exchanging OP Unitholder by the holder's non-economic,
voting securities of the Pubco.

UP-C Organizational Structure Chart
This simplified diagram depicts a typical UP-C structure following the reorganization and IPO:

© 2024 Thomson Reuters. No claim to original U.S. Government Works.

3

UP-C Initial Public Offering Structures: Overview, Practical Law Practice Note w-009-1403

Exchange Rights and Liquidity
There is no public market for OP Units. The agreements governing the OP generally contain significant restrictions on theirtransferability. However, UP-C governing documents typically provide OP Unitholders with the right to exchange OP Units
for publicly traded Pubco Shares on a one-for-one basis (see Exchanging OP Units for Pubco Shares).
Under applicable US federal income tax rules, an OP that is deemed to be a "publicly traded partnership" is also generally
subject to entity-level taxation, unless the nature of its income and operations make it eligible for continued pass-throughtreatment under applicable rules, notwithstanding that it is publicly traded (as is the case with listed master limited
partnerships). A partnership is "publicly traded" for this purpose if, among other things, its interests are "readily tradable on asecondary market or the substantial equivalent thereof." For more information on the taxation of publicly traded partnerships,
see Practice Note, Taxation of Publicly Traded Partnerships.
However, there is an exemption from these rules for partnerships having both of the following characteristics:•

The partnership's interests were issued in a private placement not required to be registered under the Securities
Act.

•

The partnership has no more than 100 partners.

© 2024 Thomson Reuters. No claim to original U.S. Government Works.

4

UP-C Initial Public Offering Structures: Overview, Practical Law Practice Note w-009-1403

When this exemption is or may become unavailable (because the OP has more than 100 partners), restrictions on exchanges
may be imposed to prevent the creation of a secondary market or the substantial equivalent in the OP Units. These additional
restrictions may include:•

Limiting a holder's right to exchange OP Units for Pubco Shares to only once a quarter.

•

Requiring exchanging holders to provide an irrevocable election well in advance of the quarterly exchange date.

OP Unitholders typically exercise their exchange rights only when they seek to exit their investment because:•

The exchange of Pubco Shares for OP Units is generally a taxable event to the exchanging holder.

•

Ownership of the business at the OP level is generally more tax efficient for the holder.

Absent registration under the Securities Act, shares issued upon exchange of OP Units are restricted securities. These
restricted securities may not be sold in the absence of Securities Act registration unless an exemption is available, suchas the exemption from registration in Rule 144. The SEC has issued interpretive guidance, however, that an exchanging
OP Unitholder's holding period of Pubco Shares for purposes of Rule 144 commences upon the acquisition of the OP Units
exchanged. This guidance:•

Permits holders holding OP Units for the requisite holding period under Rule 144 (which is commonly satisfied by
the time the customary IPO lock-up agreement with the underwriters expires) to rely on that rule to immediately
publicly resell the Pubco Shares received in an exchange, subject to the limitations of Rule 144 applicable toaffiliates of the Pubco.

•

Allows the Pubco, in most cases, to avoid having to register the issuance of Pubco Shares to exchanging OP
Unitholders, which had previously been a common and costly feature in UP-C IPO structures.

Customary registration rights, however, may still be useful for affiliates of the Pubco to enable them to resell Pubco Shares
received in exchange for OP Units without being required to comply with the volume and manner of sale limitations of Rule
144 that otherwise apply. As a result, registration rights agreements will remain a common feature of UP-C IPOs as they
are with other IPOs. For more information on resales under Rule 144, see Practice Note, Resales Under Rule 144. For an
overview of registration rights, see Practice Note, What Are Registration Rights Agreements?.

Tax Benefits
As noted above, the UP-C structure permits the pre-IPO owners to continue to hold their interests directly in the pass-throughOP and, accordingly, their share of the income of the business is not subject to an entity-level tax. In addition, the Pubco's
acquisition of OP Units from OP Unitholders, including under the exchange rights described under Exchanging OP Units for
Pubco Shares, may result in tax benefits to the Pubco and therefore reduce the amount of tax that the Pubco must pay inthe future. The Pubco usually shares a significant portion of these tax benefits with the exchanging OP Unitholder under atax receivable agreement (see Tax Receivable Agreement).

© 2024 Thomson Reuters. No claim to original U.S. Government Works.

5

UP-C Initial Public Offering Structures: Overview, Practical Law Practice Note w-009-1403

Operating Income
Under current US federal tax law:•

Partnership business income is generally taxed at a top rate of 37% to an individual partner.

•

Income earned by a corporation is taxed to the corporation at a 21% rate, and the after-tax portion (79%) is
potentially taxed again to the shareholder as a dividend.

Additionally, under current US federal tax law, “qualified business income” from partnerships, which is effectively connectedwith a US trade or business other than capital gains, dividend income, and certain compensation-related payments, iseligible for a 20% deduction. In other words, if the partnership’s income qualifies for the deduction, a taxpayer would only
be taxed on 80% of the partnership’s income, which would yield an effective tax rate as low as 29.6% (37% of 80%).
For an individual holding an interest in a partnership eligible for the favorable deduction, the flow-through income could betaxed at a US federal income tax rate roughly 7 percentage points lower than the corporate alternative (assuming distribution
as a dividend); (a) 29.6% versus (b) 21%, plus 20% of 79% or 15.8%, for a total of 36.8%. Even if the partnership’s income
is ineligible for the deduction (or partners are subject to the limitation on the amount of the deduction), individual partners
would still be subject to a rate (up to 37%) that is similar to the rate of the corporate alternative.

Capital Gains on Exit or Other Asset Sales
The UP-C structure facilitates tax-efficient post-IPO sales of partnership interests or assets. Under current US federal tax
law, individuals pay a top tax rate on long-term capital gains of 20%, compared to the top rate for capital gains of corporationsof 21%, or a double tax (corporate and shareholder) aggregating 36.8% as described above (see Operating Income). The
buyer would obtain a stepped-up tax basis for the pass-through portion of the business.

Tax Receivable Agreement
When an OP Unitholder exchanges OP Units for Pubco Shares, the transaction may result in increases in the tax basis of
the assets of the OP. The stepped-up basis increases depreciation and amortization deductions available to the Pubco.
As a result of these increased deductions, the Pubco owes less tax in the future. In a typical UP-C IPO structure, the Pubco
shares with the exchanging OP Unitholder a percentage (customarily 85%) of any tax benefits Pubco receives due to the
stepped-up basis from the exchange of the holder's OP Units. This arrangement is typically documented in a tax receivableagreement.
A tax receivable agreement commonly provides for the payment by the Pubco to an exchanging OP Unitholder of 85% of
the benefits, if any, that the Pubco is deemed to realize from:•

The increases in tax basis.

© 2024 Thomson Reuters. No claim to original U.S. Government Works.

6

UP-C Initial Public Offering Structures: Overview, Practical Law Practice Note w-009-1403•

Certain other tax benefits related to its entering into the tax receivable agreement, including tax benefits attributableto payments by the Pubco under the tax receivable agreement.

Additional tax attributes may be covered by a tax receivable agreement in certain circumstances, including existing tax
basis that does not increase upon an exchange of OP Units for Pubco shares. The term of the tax receivable agreement
customarily continues until all of the tax benefits have been used or expired (a period which can be upwards of 15 years
from the time of the applicable exchange), unless the Pubco exercises its right to terminate the agreement by paying aformulaic amount based on the remaining future payments required under the agreement (assuming, among other things,
a hypothetical exchange of all outstanding OP Units for Pubco Shares).
IPO investors have not historically viewed the UP-C structure and related tax receivable arrangements as impacting an IPO
issuer positively or negatively. The managing underwriters of a company contemplating an UP-C IPO structure shouldstill always be consulted to determine whether they expect the structure to impact the pricing or successful execution of
the offering.
For more information on tax receivable agreements, see Article, Understanding Tax Receivable Agreements.

Distributions and Dividend Policy
The owners of the OP, including OP Unitholders and the Pubco, generally incur US federal, state, and local income taxes
on their proportionate share of any taxable income of the OP. As is common in tax partnerships, the governing agreements
typically require the OP to make pro rata distributions of available cash to the holders of OP Units to fund their tax obligations
for the income of the OP that is allocated to them. These tax distributions are frequently computed based on an assumed
highest effective marginal combined US federal, state, and local income tax rate.
Because the highest effective marginal combined rates for individuals are generally higher than those for corporate entities,
these tax distributions usually result in the Pubco receiving cash in excess of the amount it requires to pay its taxes andfund its obligations under the tax receivable agreement. To avoid accruing significant cash at the Pubco level (which thenimpairs the one-to-one economic equivalency of OP Units and Pubco Shares), this "excess" cash is often distributed as adividend by the Pubco to its stockholders.
The Pubco can also establish a dividend policy that contemplates a payout that is higher than the minimum amount required
to pay taxes, in which case the Pubco causes the OP to distribute cash in excess of the mandatory tax distribution. OP
Unitholders other than the Pubco also receive their pro rata share of any distribution paid by the OP.
The enactment of US tax reform legislation in December 2017 resulted in a greater disparity between individual and corporate
rates, which generally increases the amount of excess cash received by a Pubco in tax distributions from an OP. As aresult, UP-Cs are increasingly exploring alternative uses of this excess cash in a manner consistent with their particularcommercial objectives and capital allocation strategies, such as stock repurchase programs or reinvestment in the business.
Such alternatives to the traditional dividend should be designed in a way that maintains the one-to-one economic equivalencyof OP Units and Pubco Shares.

Maintaining Parity between OP Units and Pubco Shares© 2024 Thomson Reuters. No claim to original U.S. Government Works.

7

UP-C Initial Public Offering Structures: Overview, Practical Law Practice Note w-009-1403

The UP-C structure is almost always designed and operated to maintain a one-to-one economic equivalence of OP Units
and Pubco Shares. This parity makes the structure easier for investors to understand and for the company to administerand account for in its financial reporting.
Accordingly, as noted above, the Pubco generally holds a number of OP Units that is equal to the number of Pubco Shares
it has outstanding, and maintains this relationship by taking mirroring actions in respect of its interest in the OP when it
issues or repurchases Pubco Shares.
Maintaining one-to-one equivalence also requires that, as a general matter, the Pubco not:•Hold any material assets other than its equity interest in the OP via the OP Units.

•

Become subject to liabilities (other than liabilities for taxes on its share of the income of the OP or under the tax
receivable agreement) as to which it does not have a "mirroring" claim against the OP.

In this regard, the OP and its subsidiaries are typically the primary credit support for the company's debt rather than the
Pubco. In addition, substantially all operating expenses incurred by or attributable to the Pubco (such as outside director fees,
audit fees, and expenses incurred in connection with capital markets transactions) are also typically borne or reimbursedby the OP.

Certain Considerations
The UP-C structure can be an attractive, tax-efficient option for businesses taxed as partnerships that are considering an
IPO. Practitioners and their clients should be mindful, however, of certain considerations specific to this structure particularlyin the context of strategic transactions, capital raising, and insider liquidity programs. For example:•

A sale or other change of control transaction may accelerate payment obligations under the TRA or (dependingon the terms of the agreement) result in future payment obligations that are not conditioned upon the Pubco or
successor obligor's actual realization of cash tax savings.

•

A spin-off can present unique structuring considerations, such as ensuring that public investors continue to own
their interest in the spun-off company (the "Spinco") through an entity taxable as a corporation while OP unitholders
continue to own their interest in the Spinco business through a partnership for tax purposes.

•

Changes in the number of shares outstanding at the Pubco (e.g., as a result of offerings, share repurchases, etc.)
generally need to be reflected by changes in the mirroring security at the OP to maintain the economic equivalenceof OP Units and Pubco Shares.

•

In addition to the customary policies and procedures regarding insider trading applicable to any public company, thedesign and implementation of exchange rights and liquidity programs for OP unitholders may also need to integratefeatures that address the publicly traded partnership rules described under Exchange Rights and Liquidity, as wellas additional considerations under the US federal securities laws, including Rule 144.

© 2024 Thomson Reuters. No claim to original U.S. Government Works.

8