What is a Poison Pill?
The poison pill can be termed as a defense mechanism that is applied and taken up by the target business as the last resort to discourage or stop the efforts of the acquiring business towards a hostile takeover of the target company. The target company makes the value of shares to reach at an unfavourable level so that the acquiring business cannot initiate a hostile takeover.
Explanation of Poison Pills
This is a defense mechanism ploy taken by the business which is looming under a potential hostile takeover. This is also termed as shareholder right plan wherein the value of the shares are made to reach at an undesirable level and in turn allows the target company to make itself look undesirable to the acquiring business. It makes the acquiring business to negotiate terms with the target business rather than initiating a force hostile takeover on the target business.
A hostile takeover can be regarded as the event wherein the target company has rejected the offer of the acquiring business towards a potential takeover by it but the acquiring company still continues to make an attempt to take control of the target business without the consent of the board of directors of the target business.
How does Poison Pills work?
A poison pill is initiated by allowing the existing stockholders to purchase the shares of the takeover business at price that are discounted or are below the fair market value. This event adversely impacts the interests towards the ownership for the hostile entity since the ownership is now at diluted levels.
The poison pills are initiated keeping in view and safeguarding the rights of the minority shareholders. It is also initiated to prevent the imminent changes in the management structure of the business. At times, the target company initiates the process of a poison pill to negotiate better and favourable terms towards the acquisition.
The poison pills are initiated as per the approvals of the board. The target business adopts strategies that ensures the cost of the acquisition are appreciated. In such a scenario, existing stockholders are allowed to buy additional shares at a price that is at discount thereby resulting in a dilution of ownership for the hostile entity.
Example of Poison Pills
One of the most prime example of poison pills is that of Gain Capital holdings Inc. In the year 2013, FXCM Inc attempted to acquire Gain Capital wherein the target business Gain Capital initiated the poison pill. It executed a shareholder right plan that allowed the existing shareholders to purchase 1/100th stock of the preferred stock series. The target business decided that it would distribute these rights as dividends to the common shareholders.
Types of Poison Pills
There are two broad types of Poison pills. It can be classified as the flip-in poison pills and flip-over poison pills.
1. Flip-in Poison Pills
- The flip-in poison pills enable the existing shareholders excluding acquirer to make purchase of shares at a discounted price. The purchase of discounted shares allows the shareholders to make an instant profit and simultaneously it dilutes the holdings of limited number of shares that were bought by the acquiring company.
- Before the takeover is initiated, these rights to buy additional shares are given to the shareholders. When the acquirer buys above the threshold limit, these rights gets activated. The company’s charter and bylaws document such flip-in poison pill plan and could be accessed easily on public domains.
- When a bidder is made to aware of such a strategy, he or she may discontinue the plan of taking over the target business.
2. Flip-Over Poison Pills
- The flip-over poison pills strategy enables the existing shareholders of the target company to buy the stocks of the acquiring business at a discounted rate provided the acquiring business is able to make a successful takeover. This makes acquirer to stop the activity of takeover as it could cause a potential dilution of holdings post acquisition event.
- There could be a case wherein stockholders of the target business get exclusive rights to purchase the shares of the acquiring business at the two for one rate resulting in dilution of ownership for the hostile entity.
- There are other variants of poison pills such as golden handcuffs, Voting plans, preferred stock plans and lastly voting plans. The golden handcuffs are nothing but employee stock option schemes that are given to the employees who meet specific performance metric. The stock options are active once there is an attempt of unsolicited takeover. In the voting plan mechanisms, though the acquirer has largest number of shares, but the holder of preferred stocks is vested with superior voting rights making the takeover unattractive.
Reasons for Poison Pills
The poison pills are normally performed to increase the cost pertaining to the hostile acquisitions. There are broad motives to initiate such a corporate action. The first motive is to completely stop or deter the efforts of the acquiring business to press a hostile takeover over the target business. Secondly, it is initiated to safeguard the interests of the minority shareholders itself. Lastly, the target company is playing the game of “hard to get” wherein it shows that it does not wants to be acquired but at the same time it wants to initiate favourable terms towards such as acquisitions.
Advantages and Limitations
Here we discuss the advantages and limitations are given below:
- It helps the existing management and board of directors to retain control over the company’s business operations.
- It discourages the attempts of takeovers that are of monopolistic type.
- The poison pills have the potential of damaging the long-term value of the shares issued by the business.
- It dilutes the overall holdings of the stock for existing shareholders as well and they have to buy additional shares to balance their portfolio value.
- Since takeover attempts are thwarted, the presence of incapable and ineffective managers prevails and they remain employed which results in operational inefficiency.
The poison pills also termed as a shareholder right plan is a defense tactic adopted by the target company to discourage the tries of a hostile takeover by the acquiring business. It generally attempts to increase the cost of acquisition for the acquiring company by adopting a strategy that makes the value of shares unfavorable for the acquiring business. There are two broad categories of poison pills namely flip-in and flip-over poison pills which result in dilution of ownership for the acquiring company post takeover event.
This is a guide to Poison Pills. Here we also discuss the introduction and how does poison pills work along with examples and types. You may also have a look at the following articles to learn more –