A poison pill mechanism, otherwise known as a shareholder rights plan, is a company’s defense strategy against a potentially hostile, or unsolicited, takeover attempt. There have been several instances of companies adopting this strategy as a last resort over the years.
In this article, Team YLCC explains the poison pill mechanism and how it works. Read on!
WHAT IS THE POISON PILL AND HOW DOES IT WORK?
The poison pill was invented in the 1980s by a man named Marty Lipton, who’s one of the named partners at the law firm Wachtell, Lipton, Rosen, and Katz. Wachtell basically made itself famous and very, very rich in the 1980s and 1990s defending companies against hostile takeovers, and one of the firm’s greatest inventions was the poison pill.
The name poison pill, as you might have guessed, comes from the poison pill (mostly cyanide) that spies would carry around in case they were captured by their adversaries to escape torture and interrogation.
In instances of hostile takeover, the poison pill is action taken by the target company or its Board to make it less appealing to the bidder, Typically, the strategy allows the company being targeted to flood the market with new shares, thereby diluting the hostile bidder’s ownership stake and making a takeover offer by them that much harder to swallow- or impossible, even.
Triggering a poison pill could do damage to a firm by diluting its shares’ values. The question then, is why would a company intentionally hurt itself? The answer is that the poison pill is not about hurting the company, but rather, it is designed to deter any potential buyer from acquiring too large a share in the firm without management’s consent. Ostensibly, the pill a represents a barrier in ownership that a buyer cannot cross. As such, no buyer will be able to acquire outright ownership of a firm without first coming to management (or in some cases, the court) and sitting down to negotiate any potential takeover.
Effectively, the role of a poison pill is as a first line of defense for a company to ward off hostile bidders. If a bidder would like to purchase a company that has a poison pill provision in effect, the bidder will typically buy shares of the company up to a few shares below the pill’s trigger point. At that time, the buyer will then be forced to work with management to attempt to get the pill (i.e., the rights plan) rescinded. Once the buyer is at the negotiating table, he must ask that management sponsor a resolution whereby the pill is “redeemed” by shareholders and removed from each share. If the board agrees and the pill/rights plan is rescinded, then the buyer may go ahead and complete the transaction. However, if the board is not consulted or does not like the terms of the offer made by the buyer, then management may leave the pill in place, and simply wait for a better offer or for another solution.
Here are some of the primary issues the Board should consider before adopting a poison pill, including:
- Whether adopting a poison pill is legally permissible and appropriate under the circumstances.
- The message that adopting a poison pill will send to the Company’s shareholders and to the market.
- Customized changes to the terms of a standard poison pill that could make it a more effective response to the Investor, taking into consideration the Company’s facts and circumstances.
- Options other than a poison pill, including alternative and supplemental defenses available to the Company.
TYPES OF POISON PILL
In corporate practices, there are two different types of poison pills that can be employed, depending on how it is done- Flip-In Poison Pill and Flip-Over Poison Pill.
- In case of the flip-in poison pill, except for the hostile acquirer, all of the concerned company’s shareholders can buy additional shares at a discount. The sudden purchase of additional shares culminates in good profits to other shareholders and at the same time, dilutes the value of the limited number of shares already purchased by the acquirer. However, those did not opt to purchase more shares are also diluted to some extent. In such cases, the right to purchase is offered to the target’s shareholders before a takeover is finalized and is conditional on a specific “trigger”, such as when once the hostile acquirer amasses a certain threshold percentage of total shares.
- The flip-over poison pill strategy works in a different manner by enabling the shareholders of the target to purchase the shares of the acquirer at a steeply discounted price if the hostile takeover ends up being successful. As an example, the target company’s shareholders get the right to buy the stock of its acquirer at half-price which dilutes the equity of the acquirer (and that of their shareholders).
PROS AND CONS OF A POISON PILL STRATEGY
Overall, the poison pill strategy is considered to be a fairly useful strategy when the question of ownership of a company is in a crisis. Following are its advantages:
- Poison pill strategy allows company boards to dilute ownership of a shareholder who is trying to force a hostile takeover.
- It is truly effective in making a hostile takeover harder to chieve.
- Poison pills can be used as a bargaining chip in negotiations to secure a higher price for the sale of the company
There are some disadvantages that are associated with poison pill too:
- Needless to say, employing the strategy will result in lowering of the company’s stock prices
- The availability of poison pills takes away responsibility from the company’s Board to act in their shareholders best interest.
LEADING CASE STUDIES OF POISON PILL MANOEUVRES
- Twitter v. Elon Musk (2022)
In 2022, Twitter adopted a poison pill strategy after it became known that Elon Musk has acquired a 9.1% stake in the company. The strategy was aimed at deincentivising Elon Musk from acquiring more than 15% shares in the company. If this happened, the market would be flooded with Twitter shares at discounted rates and Elon Musk would stand to lose substantially from his existing shares and it would also make a hostile takeover much more expensive. The strategy gave the Twitter Board time to evaluate Elon Musk’s offer of buying the company and also enabled the existing investors to realise the full value of their investment by reducing the likelihood of a hostile takeover. Surprisingly, the poison pill in this instance was also used by Twitter as a tool to negotiate a better deal with Elon Musk as it specified that employing the poison pill will not prevent its Board from “engaging with parties or accepting an acquisition proposal” at a higher price.
- Netflix v. Carl Icahn
In the November of 2012 world’s leading content streaming service Netflix was compelled to adopt a poison pill to ward off infamous corporate raider Carl Icahn’s attempts to take over the company and make it an appealing bait for bigger conglomerates in the video business such as Microsoft, Apple, Google, Amazon, Verizon and Comcast. Carl Icahn acquired a 10% stake in late October of 2012 prompting Netflix’s alarm bells to set off and adopt a unique ‘stockholder rights plan’.
YLCC would like to thank its Content Team for their valuable insights in this article.
