Proration

What is proration?

Proration is a corporate action used to allocate limited consideration (cash or shares) among shareholders when demand exceeds the available supply. It commonly arises during mergers and acquisitions when an acquiring company offers a mix of cash and equity and target shareholders can elect which form of payment. If more shareholders elect a particular form than the acquirer can deliver, the company reduces each elected amount proportionally so all shareholders receive the same treatment.

Proration is distinct from the term pro rata, which describes any proportional allocation; proration specifically refers to this adjustment in corporate transactions.

How proration works

• The acquirer sets an initial mix of cash and shares (for example, 75% cash / 25% stock).
• Target shareholders choose either cash, stock, or a mix according to the terms.
• If total elections for cash (or shares) exceed what the acquirer can provide, the company applies a proration factor to reduce each election by the same proportion.
• The result ensures fairness: everyone who elected the oversubscribed option receives the same fraction of their election.

Mathematically:
– Proration factor = available amount / total elected amount
– Actual payment per election = election × proration factor

Example

An acquirer offers $100 million total consideration: 75% cash ($75M) and 25% stock ($25M). Target shareholders elect $90M in cash and $10M in stock. Because only $75M cash is available:
– Cash proration factor = 75 / 90 = 0.8333
– Each shareholder who elected cash receives 83.33% of their requested cash
– The shortfall is typically made up by share payments according to the deal mechanics and the terms disclosed in the proxy or offer documents

When proration occurs

Common scenarios include:
– Mergers and acquisitions with optional cash/equity consideration
– Special dividends where declared cash exceeds available resources
– Stock splits, spinoffs, bankruptcy, or liquidation distributions when allocations must be limited
– Any corporate action requiring proportional distribution when supply is constrained

Proration factor

The proration factor is the fraction used to scale each shareholder’s election so that the total distributed equals the available amount. It can apply to cash or shares independently:
– Cash factor = available cash / total cash elections
– Share factor = available shares / total share elections

Some contexts (e.g., pension plans) use “proration factor” to describe entitlement proportions for participants.

Proration in accounting

In accounting, proration refers more broadly to allocating costs or resources proportionally across accounts or reporting periods—for example, apportioning overhead between finished goods and work-in-progress when closing books.

Considerations

• Shareholder elections and proration rules are typically disclosed in the proxy statement or offer documentation; shareholders should review these terms before casting elections.
• Tax implications and investment preferences (immediate cash vs. potential growth in shares) often drive election choices.
• Proration preserves fairness but means shareholders may not receive their full initial election.
• In mergers, regulators (e.g., antitrust authorities) may also influence deal structuring; firms consider competitive and legal issues when planning offers.

Key takeaways

• Proration adjusts shareholder payments proportionally when demand for cash or shares exceeds supply.
• It ensures equal treatment by applying a uniform proration factor to all elections.
• Proration appears in M&A, dividends, reorganizations, and accounting allocations.
• Shareholders should read offer documents to understand proration mechanics and potential tax consequences.