The Do’s and Don’t’s of Pro-Rata Share Ownership

There are three ways that a securityholder’s allocable portion of any post-closing transaction consideration can be determined under the definitive agreement:

  1. The ownership percentage determined by calculating the cash received at closing by such securityholder over the total cash distributed at closing to all securityholders.
  2. The ownership percentage determined by calculating the number of fully diluted shares held by such securityholder over total fully diluted shares held by all securityholders.
  3. Any remaining amounts due to such securityholder in accordance with liquidation preferences set forth under the company’s organizational documents.

In our experience, the first two allocation methods are used most frequently in merger agreements and can cause post-closing issues when funds are to be distributed. Some simple drafting changes can avoid these issues and help to ensure a timely distribution.

While it may sound simple, merger parties need to ensure that the defined terms for ownership percentages set forth in the definitive agreement match those used in the allocation spreadsheet.

We often find that the definitive agreement may use the first method to define pro-rata share, while the allocation spreadsheet uses the second method or vice versa. In a transaction where there are no optionholders or preferred stock, a discrepancy between the agreement and the spreadsheet based on cash received vs. shares held does not present any material issues. However, if there are optionholders or liquidation preferences, this can cause a serious disparity in distribution amounts.

Optionholders’ closing consideration is typically reduced by the exercise price for each option grant. This results in the closing consideration per vested option held being less than the common price per share. As such, if the definitive agreement defines the ownership pro-rata share as calculated using the number of shares or options held, while the allocation spreadsheet calculates the distributions using the cash received at closing, the optionholders’ allocation percentages will be significantly lower than their deemed equity ownership. Alternatively, if a preferred holder received additional funds at closing due to their liquidation preference, their pro-rata share will be unfairly inflated if calculated off of cash received at closing versus shares held on an as-converted basis.

In our experience as Payments Administrator on almost 1,700 post-closing distributions since 2015, we know how important it is that funds be distributed quickly and efficiently to the shareholders. These issues can cause delays at the time of a release as the issue is discussed among parties and the allocation spreadsheet is amended. As such, it would serve the deal parties to ensure the intent of the defined terms is being applied on the allocation spreadsheet and that the definitive agreements reference a method of allocation for any potential funds that are distributed to shareholders.

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