Toehold Position/Purchase
An investment strategy to get your foot in the door.
What is a Toehold Position/Purchase?
A toehold position is an acquisition or investment strategy where an investor targets a particular company but buys less than 5% of the company’s stock. This “toehold” position is sufficient to enable them to exert pressure on the company, whether aiming to ultimately acquire it or merely to raise its performance and improve returns. Due to the small ownership percentage, the purchase does not need to be filed with the Securities and Exchange Commission (SEC).
Essentially, the toehold position gets the investor’s foot (or toe) in the door of the company. It is often the first step made by an investor who is looking to acquire the company.
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How Does a Toehold Position Work?
As mentioned, a toehold position is simply a small but significant equity position with a company. The position taken does not exceed 5% of the company’s outstanding shares – this is in order to avoid having to report the purchase to the Securities and Exchange Commission.
Only a purchase above the 5% threshold requires the buyer to file a notice with the SEC explaining what their intentions are. The notice to the SEC must include whether more shares are going to be purchased, how many, and for what reason. This filing would necessarily reveal any potential takeover attempt.
Once the toehold position has been taken, the investor – or investment firm – is likely to begin making additional purchases of the target company’s outstanding shares. The investor typically continues with small percentage purchases of shares that can be done quietly. The small purchases are more than likely to go unnoticed or, if noticed, to be viewed as non-threatening by the company.
Alternatively, rather than aiming at acquisition, a toehold position can be used as a way to exert pressure on the company, to influence its decisions. This is usually done to push the firm’s board to make decisions that will increase its market value, thereby increasing investment returns for the investor.
Acquisitions and Takeovers
As noted, an investor or investment firm often makes use of a toehold position when they are planning on making a move toward the takeover of the company whose shares they’ve purchased.
A toehold position is the first in a series of strategic moves an investor makes when it looks to acquire or take over the target company. The primary goal – when pursuing an acquisition or takeover – is to quickly and quietly build up a cache of the target company’s outstanding shares. This enables the acquirer to gradually obtain a greater equity interest in, and more control of, the target company.
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Summary
A toehold position strategy is specifically useful to a company pursuing a hostile takeover. Establishing a toehold purchase can go undetected. The buying company can rapidly snatch up small portions of equity interest in the company, with no need to report its purchases or intent to the SEC, provided their purchases don’t cross the 5% threshold.
Additional Resources
CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below!
