What is proratization?
Prorated is a situation that can arise during a specific securities transaction, such as an acquisition. In certain situations, the acquiring business will offer a combination of cash and equity, and shareholders of the acquired business can choose to take either one. After the election of the shareholders, the remaining stock is calculated on a pro rata basis if the available cash or shares are not sufficient to meet the offers of the shareholders. If this happens, the company allocates part of the cash and shares for each offer presented so that everyone always receives their fair share of the transaction. Pell scholarships can also be prorated in specific circumstances, allowing a person to be paid to go to university.
Understanding the pro rata
Proration supports shareholders by ensuring that a company can meet its original objective and not favor certain investors over others (for example, by giving a percentage of shareholders the liquidity they want while delivering actions to others). Although this means that each investor may not receive their initial election; it guarantees that all investors receive the same reward.
Other situations in which the need for proration could arise include bankruptcy or liquidation, special dividends, stock split and fallout. Although these securities transactions must be approved by the shareholders, and a company will generally register them on a company proxy, filed before the annual meeting of a public company, individual shareholders still sometimes have to sacrifice to maximize the wealth of all shareholders.
Key points to remember
- The prorated calculation refers to situations where a company shares its initial offer in cash and shares to take into account the choices of investors.
- Mergers and acquisitions, stock splits and special dividends are examples of cases in which a pro rata allocation can take place.
Pro rata and other merger considerations
Mergers occur for a number of reasons, including gaining market share through a horizontal merger, reducing operating costs through a vertical merger, expanding into new markets and / or uniting common products through Congeneric merger, all to increase revenues and increase profits for the benefit of the company’s shareholders. After a merger, the shares of the new company are distributed to the existing shareholders of the two original companies.
An example of a merger of two companies in separate industries is the 2020 Amazon / Whole Foods merger, which has received huge attention from investors and the media. Amazon acquired the organic grocery chain Whole Foods for $ 13.7 billion in cash, following shareholder and regulatory approval. For Amazon, this represented a major step forward in its attempt to sell groceries online and its competition with grocery retailer Walmart. For Whole Foods, this has resolved some of its financial difficulties.
When deciding to merge, in addition to how the two companies will reward shareholders, it is important to consider the Federal Trade Commission’s guidelines on maintaining the competitiveness of the sector and avoiding the creation of monopolies. For example, it is important to consider whether a proposed merger will create or strengthen market power or not. An antitrust concern arises in particular with the proposed horizontal mergers between direct competitors.
Suppose a company decides to acquire another outfit for $ 100 million, which consists of 75% cash and 25% equity. The cash-equity distribution could be revised if the majority of the investors in the acquired company choose to be paid in cash. In this case, the acquiring company will modify its accounting figures in order to meet the demand for liquidity. Thus, each investor in the acquired company will receive less cash than initially planned. Halliburton had to revise its original 2020 share buyback offer and reduce it by a factor of 67.9% in order to balance investor demand and its share price at that time.