What is a Pre-offer Defense Mechanism?
Pre-offer defense mechanism is a general term for a broad group of defensive strategies in M&A transactions. Essentially, the pre-offer defense mechanism is a preemptive strategy undertaken by a target company to protect itself from a possible bidding offer from a would-be acquirer in a hostile takeover.
Objectives of Pre-offer Defense Mechanisms
The goal of pre-offer defensive strategies is to minimize the probability of a hostile takeover succeeding, by increasing the financial burden on a potential bidder (i.e., increasing the total acquisition costs of a deal) and, thus, making a target company less attractive to a bidder. Alternately, pre-offer defense mechanisms can refer to setting up various corporate governance restrictions to limit the voting and decision-making power of a hostile bidder. These defense mechanisms, rather than being an immediate response to a takeover attempt, are things that are usually established or put in place well in advance of any actual takeover bid.
Types of Pre-offer Defense Mechanisms
Pre-offer defense mechanisms can be divided into different categories based on the means employed to achieve the goal of reducing the probability of a successful hostile takeover. The first category of pre-offer defense strategies primarily deals with corporate securities. Such defense mechanisms include:
1. Poison pill
The poison pill tactic is probably one of the most well-known defensive strategies. The main idea of the strategy is the dilution of the company’s shares and the concentration of power among the existing shareholders. There are two types of poison pill strategy:
2. Flip-in poison pill
The flip-in poison pill is a provision in the corporate governance enabling the current shareholders of a target company to purchase additional shares at a discount. Generally, the discount for the purchase of additional shares is significant.
3. Flip-over poison pill
The flip-over poison pill is a provision that allows the shareholders of a target company to purchase shares in the acquiring company at a discounted price. The flip-over defense is essentially a direct counterattack, where the target company threatens to take over the acquiring company.
4. Poison put
Essentially, the poison put defensive strategy is a variation of the poison pill strategy. Under the poison put strategy, the target company issues bonds to investors that can be redeemed prior to their maturity date, at a discount price. Note that the bonds can be redeemed before their maturity date only after the submission of a hostile takeover bid.
The second category of pre-offer defensive mechanisms includes strategies known as shark repellents. The shark repellents do not impact the shareholders of the target company but creates challenges in corporate governance for a potential bidder or increases the total acquisition costs. Examples of shark repellents are:
1. Golden parachutes
Golden parachutes are referred to as clauses in the employment contracts of the target company’s managers that award the managers substantial benefits and/or bonuses if their contract is terminated. The goal of the golden parachutes is to put a bigger financial burden on a potential hostile bidder.
2. Supermajority provisions
These are amendments in the corporate charter of a target company that require a substantially large percentage of shareholders (generally between 70% to 90%) to approve important corporate matters such as an acquisition of a company. The supermajority provisions modify the generally accepted majority provisions that require the approval of only more than 50% of the company’s shareholders. Generally, the amendments aim to increase the total cost of an acquisition, as the acquirer must purchase many more shares in order to establish effective control of the target company.
3. Staggered board of directors
A staggered board of directors is a practice in corporate governance in which the board is divided into separate groups, with different service terms. Such a governance structure implies that the whole board of directors cannot be replaced at once. Thus, even if a corporate raider acquires a substantial interest in a target company, it will not be able to exercise its voting power sufficiently to override the target’s board.
4. Strategic incorporation
A company may strategically select the jurisdiction of its incorporation to prevent the possibility of a hostile takeover. The strategic incorporation strategy involves choosing a jurisdiction for incorporation with considerable restrictions on merger and acquisition deals. The most notable examples of such restrictions are anti-competition laws (in the United States, they are known as antitrust laws).
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