Pro rata shares: Overview, definition, and example
What are pro rata shares?
Pro rata shares refer to the allocation or distribution of something, such as profits, expenses, or ownership, in proportion to an individual’s or entity's share or stake in a total amount. "Pro rata" is a Latin term meaning "in proportion." In the context of shares, pro rata typically refers to a situation where shareholders or investors receive an amount that corresponds to their proportionate share of a total offering, asset, or distribution.
For example, if a company issues new shares, pro rata allocation ensures that each existing shareholder receives an amount of new shares in proportion to their current holdings, maintaining their relative ownership percentage.
Why are pro rata shares important?
Pro rata shares are important because they ensure fairness and equity in financial or ownership distributions. This method allows parties to receive a fair and proportional share of any benefit, such as dividends, profits, or stock issuance, based on their existing stake.
For businesses, offering pro rata shares ensures that each shareholder maintains their proportionate interest in the company after new shares are issued or assets are distributed. This principle is widely used in corporate finance, mergers, acquisitions, and dividend distributions.
Understanding pro rata shares through an example
Imagine a company, ABC Corp., with three shareholders: Alice, Bob, and Carol. Alice owns 50% of the shares, Bob owns 30%, and Carol owns 20%. The company decides to issue 1,000 new shares.
Using a pro rata distribution, Alice would be entitled to 500 new shares (50% of 1,000), Bob would receive 300 new shares (30% of 1,000), and Carol would receive 200 new shares (20% of 1,000). This ensures that each shareholder’s relative ownership in the company remains the same.
In another example, a company decides to distribute profits to its shareholders based on their shareholding. If the company has $100,000 in profit to distribute and shareholder Alice owns 10% of the company, she would receive $10,000 (10% of $100,000) in pro rata shares of the profit.
An example of a pro rata shares clause
Here’s how a pro rata shares clause might appear in a shareholder agreement or offering document:
“In the event of an additional issuance of shares by the Company, the existing shareholders shall be offered the opportunity to purchase new shares on a pro rata basis, in proportion to the number of shares they currently hold, in order to maintain their relative ownership percentages.”
Conclusion
Pro rata shares ensure that each shareholder or investor receives a distribution that is proportional to their ownership stake. This principle is widely used in situations such as stock issuance, profit distribution, and ownership adjustments, and it helps maintain fairness and equity among stakeholders.
For SMB owner-managers, understanding how to apply pro rata shares in business transactions, stock issuance, or dividend distributions is crucial for ensuring fairness and maintaining the trust of shareholders or investors.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.