What it means
In a small partnership, ownership is often described as percentages, such as 60% and 40%. Larger or more formal partnerships divide ownership into units, which makes it easier to admit new investors or let existing ones sell.
A partner who owns 5,000 out of 100,000 units has a 5% interest. The partnership agreement is the key document.
It sets out the number of units, how profits and losses are shared, how much each unit paid, what voting rights attach and how units can be bought, sold or redeemed. Different classes of units may carry different rights, such as a priority claim on distributions.
Units are widely used in private equity funds, real estate partnerships and, in some countries, in master limited partnerships whose units trade on a stock exchange. Investors in limited partnerships typically enjoy limited liability for the debts of the business, while a general partner manages the partnership and may carry greater liability.
The details depend on local law and should be confirmed with advisers. For tax, a partnership is often treated as transparent, which means that profits flow through to the partners in proportion to their units and are taxed in their hands.
This can produce a tax bill even in a year when the partnership has not paid out any cash. Anyone buying units should understand how distributions and taxable allocations may differ.
Valuing a unit requires a view of the partnership's net assets or earnings. A simple measure is the net asset value per unit, but a unit that is hard to sell may be worth less than its share of the underlying assets because of restrictions on transfer.
When new units are issued at a price below the value of existing units, current partners can be diluted. Existing partners therefore often negotiate pre-emption rights, which let them buy new units first to protect their percentage.
In practice
Real-world examples
Example 1
A group of eight doctors forms a partnership to own a medical building, splitting ownership into 1,000 units. One doctor retires and sells her 150 units to a colleague. The partnership agreement specifies the price formula, so the sale is quick and nobody has to argue about the value. The other partners simply update the register of units.
Example 2
A private equity fund is organised as a limited partnership, and investors commit $50,000,000 in exchange for units. The general partner calls capital as investments are made. Distributions are paid out according to the unit holdings and the agreed profit share. Investors receive an annual statement showing their share of income for tax purposes.
Example 3
A pipeline company's partnership units are listed on a stock exchange. An investor buys 2,000 units at $25 each, paying $50,000. She receives quarterly distributions and a tax statement showing her share of the partnership's income.
Think of it
Partnership units are like slices of a birthday cake. The whole cake is the business. If the cake is cut into ten equal slices, owning two slices gives you one fifth of the cake, and one fifth of the joy when everyone eats it.
Formula
Calculation
Ownership percentage = units held / total units outstanding x 100; Value per unit = partnership net asset value / total units outstanding
Suppose a property partnership has 1,000,000 units outstanding and a net asset value of $20,000,000. Value per unit = 20,000,000 / 1,000,000 = $20. An investor holding 50,000 units owns 50,000 / 1,000,000 x 100 = 5%, and her stake is worth 50,000 x 20 = $1,000,000. If the partnership issues 250,000 new units, her ownership falls to 50,000 / 1,250,000 = 4%.Case study
Seen in the real world
Larkfield Hospitality Partners is a fictional partnership created for this illustration. It owned a small hotel and was divided into 10,000 units, with the founders holding 6,000 and eight outside investors holding 4,000.
When the hotel needed $1,500,000 for a refurbishment, the partners agreed to issue 3,000 new units at $500 each. The agreement gave each existing holder the right to buy new units in proportion to their holdings.
The illustrative outcome was that two investors took up their rights and kept their percentages, while one declined and was diluted from 5% to about 3.8% (500 out of 13,000 units). The episode showed the importance of reading the partnership agreement before investing. It also led the partners to add a clear notice period for future offers, so that every holder has time to find the money.
Watch out
Common mistakes
- Treating units like ordinary company shares, when the legal and tax rules for partnerships are often different.
- Ignoring restrictions on selling, which can make units hard to turn into cash when an investor needs the money back.
- Forgetting that taxable profit may be allocated to unit holders even when no cash is paid out.
Questions
People also ask
How is a unit different from a share?
A share represents ownership in a company with its own legal identity and tax position, while a unit represents an interest in a partnership whose profits usually pass straight to the partners.
Can partnership units be sold?
Usually yes, but the agreement may require consent from other partners, set a price formula or limit who may buy them.
Do all units carry the same rights?
Not always, since some partnerships have different classes of units with different voting rights or priority on distributions.