Class A and Class B LP Units: Two Ways to Take the Same Deal
Offering two classes lets a sponsor sell the same deal to two different appetites. It also creates the only decision most limited partners are ever actually given.
Some offerings present a choice. Class A units pay a higher preferred return and take little or none of the upside. Class B units pay a lower preferred return and share fully in what comes after.
It is one of the few genuine decisions a limited partner gets to make in a syndication, and it is usually presented as a preference question — do you want income or growth? — when it is really a question about which outcome you think is likely.
What the two classes typically look like¶
There is no standard. The labels are chosen by the sponsor's counsel and mean whatever the agreement says they mean. That said, a common shape:
| Class A | Class B | |
|---|---|---|
| Preferred return | Higher, often 9% to 11% | Lower, often 6% to 8% |
| Participation in the split above the preferred | None, or a small share | Full share |
| Priority on distributions | Ahead of Class B | Behind Class A |
| Priority on liquidation | Often ahead, but read the clause | Behind |
| Best outcome for this class | The deal is ordinary | The deal is very good |
| Worst outcome | The deal fails; priority over a zero is a zero | The deal is ordinary and the upside never arrives |
The economics are a trade of variance for level. Class A is buying a higher floor and selling the ceiling. Class B is doing the opposite.
Where they cross¶
The classes produce identical outcomes at exactly one level of performance, and diverge in both directions from there. Finding that crossover point is the whole analysis, and it can be done on one page.
That is the entire structure of the decision. Class A is a bet that the deal will be ordinary. Class B is a bet that it will not.
The clauses that change the answer¶
Four provisions can invert the arithmetic above, and all four are in the agreement rather than the summary.
Is Class A's preferred cumulative and compounding? A higher rate that does not accrue when unpaid is worth much less than the headline. See cumulative and compounding preferred returns.
Does Class A have a liquidation preference, or only a distribution priority? These are different. A distribution priority orders the payments; a liquidation preference orders the claims on the proceeds of a sale. An agreement can give Class A the first and not the second, in which case its priority evaporates at exactly the point it matters most.
Is Class A capped, or does it participate after a point? Some structures give Class A a small residual share after a high hurdle. That changes the shape from flat to slightly rising.
Where does the promote sit relative to both? In most two-class deals the sponsor's promote is calculated on the Class B economics only, but not always, and if it is charged across both then Class A's stated return is not what it appears.
The questions that make the classes comparable¶
Because the labels are not standardized, comparing two offerings that both have Class A and Class B units means comparing definitions rather than names.
Two further points that are easy to miss.
The classes may not be equally sized. A structure in which Class A is a small slice sitting ahead of a large Class B behaves very differently from one where the classes are similar in size, because the amount of capital ahead of the junior class determines how much of a shortfall it absorbs.
Class A capital can behave like preferred equity. Where the priority is large, the rate is high and it accrues, the junior class is holding an option rather than an equity position — which may be the right trade at the right price, and is a different instrument from what the phrase "limited partner units" suggests.
Who each class actually suits¶
Not advice, and not a recommendation — an observation about what each structure is designed to do.
Class A is designed for capital that wants a defined, higher current return and does not need the upside: it behaves more like a fixed income position with equity risk. Its worst feature is that it takes full downside exposure while its upside is capped, which is a poor trade in a deal that fails.
Class B is designed for capital that is buying the business plan. Its worst feature is that in a mediocre outcome it earns a low preferred return and never reaches the split, which means it accepted less current income for an upside that did not arrive.
The genuinely useful exercise is not choosing in the abstract but modeling both against the deal's own pro forma, then modeling both again with the exit capitalization rate expanded and rent growth halved. Where the crossover sits under the sponsor's assumptions and where it sits under conservative ones are two different numbers, and the gap between them is the actual decision.
Primary sources
Every factual claim above is traceable to a filing, a rule or an agency publication. These are the ones this article relies on.
Questions readers ask
What is the difference between Class A and Class B units?
Class A typically receives a higher preferred return with limited or no participation in the profit split. Class B receives a lower preferred return and full participation in the upside. The labels are not standardized, so the class definitions in the agreement are what matter.
Which class should I choose?
That depends on the outcome, which is unknowable at subscription, and on your own preference for certainty over upside. The honest approach is to model both across a range of exits and see where they cross.
Is Class A safer?
It has a priority, which helps in weak outcomes, and in some agreements a liquidation preference as well. It is not safe: both classes are common equity relative to the debt, and both can lose everything.
Do the two classes vote together?
Sometimes, and sometimes not. Voting rights are set by the agreement and can differ by class, which matters for removal provisions and for consent to new capital.
Does the split of a deal into classes cost anything?
Not directly, but it complicates the waterfall and the tax allocations. It is worth confirming the classes are described consistently in the memorandum summary and in the operative distribution provisions.
Read next
- StructuresHow a Real Estate Syndication Is Actually StructuredA syndication is two things stacked on each other: a piece of commercial property finance, and a securities offering sold under an exemption from registration.
- StructuresLLC vs Limited Partnership: Which Entity Holds the PropertyBoth give passive investors limited liability and pass-through taxation. The differences are the sponsor's exposure and which document to ask for.
- StructuresRegulation D 506(b) vs 506(c): What Changes for the InvestorOne exemption forbids advertising and takes your word on accreditation. The other permits public marketing and requires documentary proof.