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Poison Pill

A defensive strategy to dissuade any hostile takeovers

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 hostile takeover. It is a technique by which 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 bad 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.

 

poison pill shareholder rights plan theme

 

History of the Poison Pill

The poison pill term originated from the era of wars and espionage, when 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. Poison pill tactics were designed to discourage a potential acquirer from pursuing a takeover.

The 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 diluting the equity, making the acquisition much more expensive to pursue (since Pickens would have to purchase many more shares to gain a co).

At that time, this tactic was seen as controversial and possibly a breach of fiduciary duty. The poison pill strategy, 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 goals 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 strategy is known as 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 bought 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.

 

Effectiveness

Poison pills can be very effective in dissuading a purchase but are often not the first line of defense. This is because the strategy is not entirely guaranteed to work, as a poison pill will not necessarily prevent the acquisition of the corporation if the acquirer is persistent. Furthermore, this tactic may weaken the company if employed incorrectly.

 

Examples of Poison Pills

In 2012 Netflix adopted a Poison Pill (shareholder rights plan) to fend off Karl Icahn from effecting a  hostile takeover. Upon learning that Icahn had acquired a 10% stake in the company, Netflix immediately went on the defensive. Any attempt to buy a large equity position in Netflix without board approval would result in flooding the market with new shares, making any stake attempt very expensive.

 

Summary

Shareholder rights plans, or poison pills, are measures that a company may implement to discourage a hostile takeover. Poison pills appeared in the United States as a response to the numerous hostile takeovers that occurred in the 1980s. A poison pill does not always mean that companies do not want to be acquired or merged. Sometimes they are used to force the acquirer to negotiate takeover terms more favorable for the target company.

 

Additional resources

Thank you for reading this CFI guide to takeover defense strategies. To keep learning and advancing your career in corporate finance, we highly recommend these additional CFI resources:

  • Mergers and acquisitions process
  • DCF modeling guide
  • Investment banker salaries
  • Financial modeling guide

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