(Reuters) - Energy Transfer Equity LP (>> Energy Transfer Equity LP) has progressed to the second round of bidding for Williams Companies (>> Williams Companies Inc), according to people familiar with the matter, a key milestone in the pipeline company's efforts to clinch a friendly deal with its peer.

Energy Transfer has tied up at least seven investment banks that are now working on its bid, the people said, narrowing the financing options for rivals looking to compete for Williams, which has a market capitalisation of around $39 billion (25 billion pounds).

The sources asked not to be identified because details of the sale process are confidential. Representatives for Williams and Energy Transfer declined to comment.

Williams decided to put itself on the auction block after it rejected an all-stock acquisition proposal from Energy Transfer in June, worth $53.1 billion at the time including the assumption of debt, aimed at disrupting Williams' plans to acquire its pipeline subsidiary Williams Partners LP (>> Williams Partners L.P.) for $14 billion.

Energy Transfer will now have to outbid other suitors for Williams to avoid a hostile takeover. The sources said that Williams had attracted other bidders, though it could not be immediately established which other companies made it through to the second round.

Houston-based pipeline firms Kinder Morgan Inc (>> Kinder Morgan Inc), which has a market capitalisation of $73 billion, and much smaller Spectra Energy Corp (>> Spectra Energy Corp.) which has a market capitalisation of $20 billion, had expressed interest in Williams, the people said. Kinder Morgan would face significant antitrust hurdles because of its size, the people added.

Kinder Morgan and Spectra representatives declined to comment.

The universe of companies that would be in a position to pursue Williams also includes TransCanada Corp (>> TransCanada Corporation), Enbridge Inc (>> Enbridge Inc), Enterprise Product Partners LP (>> Enterprise Products Partners L.P.) Phillips 66 (>> Phillips 66) and Marathon Petroleum Corp (>> Marathon Petroleum Corp), industry sources have said.

TransCanada, Enbridge, Enterprise and Marathon did not immediately respond to requests for comment. Phillips 66 declined to comment.

Deals in the energy sector, especially oil and gas pipeline and processing companies, are turning to a more traditional corporate structure as advantages associated with a master limited partnership (MLP) wane over time.

Energy Transfer would be the latest MLP to propose using a C-corporation as a way to maximize tax advantages, increase cash flows and broaden institutional interest.

The sector had previously embraced the MLP structure because the tax burden is passed through to investors who receive fat yields. Because the partnership pays no taxes, it has a lower cost of capital.

(Reporting by Mike Stone and Greg Roumeliotis in New York; Editing by Cynthia Osterman)

By Mike Stone and Greg Roumeliotis