What is a poison pill?
The poison pill technique, sometimes also known as a shareholder rights plan, is a form of defense against a potential takeover. The Poison Pill is a structural maneuver designed to thwart attempted takeovers, where the target company seeks to make itself less desirable to potential acquirers.
Poison pill tactics may also be employed to soften the blow of a hostile takeover. As often is the case in hostile acquisitions, the acquiring company will employ abusive takeover tactics, or use its dominant position to put the target company in a very low position. In these cases, poison pills may be utilized to force the acquirer into a position to negotiate, instead of simply forcing acquisition on the target.
History of the Poison Pill
The poison pill term originated from the era of wars and espionage, where spies carried toxic pills that could be ingested to avoid capture. Spies would swallow these pills if they thought they were about to be caught, similarly to how a target company may employ poison pill tactics to avoid hostile takeovers.
In the world of corporate finance, the “poison pill” term originated in the United States. These tactics were designed to have detrimental effects to any acquirer who, if by aggressive means, decided to take over the company employing the poison pill.
The term and tactic was first employed by the firm Wachtell, Lipton, Rosen and Kantz. Martin Lipton invented the tactic as a defense during a takeover battle in the 1980s. His client, a firm called General American Oil, was in the sights of T. Boone Pickens. Martin Lipton advised the board of directors of General American Oil to flood the market with new shares of the company’s stock, thereby reducing the value of each individual share. This effectively diluted the ownership that was to be potentially acquired by Pickens, discouraging the unsolicited acquisition.
At the time, this tactic was seen as controversial, and may have been seen as a breach of fiduciary duty. The poison pill, however, was ruled legal in 1985 by the Delaware Supreme Court.
Types of poison pills
Since Lipton employed the poison pill, various techniques have developed. The general idea, however, is to dissuade any outside takeover attempt by either making the company less desirable or by putting current shareholders at a higher point of power. Both of these can be accomplished by selling cheaper shares to existing shareholders, thereby diluting the potential equity an acquirer receives, and also providing more equity to existing shareholders.
A common type of poison pill is the flip-in provision.
The “Flip-In” Provision
The flip-in strategy entitles existing shareholders to acquire shares of the company at a discount. This discount is often substantial, allowing existing shareholders to consolidate their equity claim in the portion of the company that is not acquired by the acquirer. This right to purchase is given before the takeover or acquisition is finalized, and will often be triggered when the acquirer surpasses a certain ownership percentage threshold. The purchase of discounted shares of the company dilutes the acquirer’s equity, reducing the value received for the price paid by the acquirer. All shareholders are also now equally less powerful when it comes to board votes, because each share now holds less of the overall company. However, existing shareholders (excluding the acquirer) will have effectively concentrated power due to the purchase of discounted shares.
Poison pills can be very effective in dissuading a purchase, but are often not the first line of defense. This is because it is not entirely guaranteed to work, as a poison pill will not necessarily prevent the acquisition of the corporation if the acquirer is persistent or knowledgeable. Furthermore, poison pills may weaken the company, if employed incorrectly.
Real life example
In 2012 Netflix adopted a Poison Pill (shareholder rights plan) to fend off Karl Icahn from a hostile takeover. Upon learning that Icahn acquired a 10% stake in the company, Netflix immediately put on the defensive by swallowing a poison pill. In doing so, they prevent Icahn from continuing to receive a higher stake in the company, by making it more costly to do so. Any attempt to buy a large position of ownership of Netflix without board approval would result in flooding the market with new shares, making any stake attempt expensive.
Shareholder rights plans, or poison pills, are measures that a company may implement to discourage a hostile takeover by another company. Poison pills appeared in the United States as a response to the countless takeovers that occurred in the country in the 1980s, and its main purpose was to protect minority shareholders and avoid the change of control. A poison pill does not always mean that companies do not want to be acquired nor merged; sometimes they are put into effect to get more appropriate acquisition/merger conditions.
This has been a guide to a poison pill or shareholder rights plan. To keep learning and advancing your career in corporate finance, we highly recommend these additional resources below: