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Poison Pill Meaning, Definition & Example

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The term “poison pill” refers to a defence strategy used by a target company to deter or prevent a hostile acquisition by a competitor.

This approach is used by potential targets to make themselves appear less appealing to a potential buyer.

Poison pills are often quite successful, even if they aren’t necessarily the first—or best—way to defend a corporation.

Important:

• A poison pill is a deterrent used by a target firm to deter or prevent hostile takeover efforts.

• Poison pills give existing shareholders the option to buy more shares at a lower price, effectively diluting a new, hostile party’s ownership stake.

• The flip-in and flip-over methods are common in poison pills.

Poison Pills: What You Need to Know

Poison pills

In the corporate sector, takeovers are rather regular, where one company offers to take control of another.

When a larger company seeks to enter a new market, when there are operational benefits to uniting both firms, or when the acquirer wants to reduce competitors, it will typically purchase a smaller company.

Takeovers, on the other hand, aren’t always pleasant and might turn nasty if the target refuses to entertain or desire to be taken over.

The poison pill strategy was developed by the New York-based law firm Wachtell, Lipton, Rosen, and Katz in the 1980s.

The name stems from the poison pills that spies used to avoid being interrogated by their enemy if they were caught.

It was created to prohibit an acquiring business from purchasing a majority stake in a potential target or directly negotiating with shareholders at a period when takeovers were becoming increasingly widespread.

When a corporation is threatened with a hostile takeover, it may employ the poison pill method to make itself less appealing to the possible buyer.

A poison pill, as the name implies, is something that is difficult to take or accept. A poison pill can be used by a company facing an undesirable takeover to make its shares unappealing to the acquiring firm or individual.

Poison pills also boost the cost of purchases greatly and offer significant disincentives to entirely prohibit such attempts.

The system protects minority shareholders and prevents the company’s management from changing hands.

The use of a poison pill does not always imply that the company is unwilling to be bought. It may be used to obtain a higher purchase price or more advantageous terms in some cases.

Particular Points to Consider

Because shareholders—the company’s actual owners—can vote by a majority in favour of the acquisition, the target company’s management uses a poison pill, which is typically a carefully formulated shareholder rights plan with particular criteria established specifically to block attempted takeovers.

Poison Pills Come in a Variety of Forms

The flip-in and flip-over poison pill tactics are the two sorts of poison pill strategies. The flip-in option is the more popular of the two options.

Poison Pill (Flip-in)

Allowing all shareholders, excluding the acquirer, to purchase additional shares at a discount is known as a flip-in poison pill technique.

While purchasing additional shares offers stockholders with immediate benefits, the practise dilutes the value of the acquiring company’s limited number of shares already owned.

This right to purchase is granted to shareholders before the takeover is completed, and it is usually activated when the acquirer obtains a particular percentage of the target company’s shares.

Here’s an illustration. Assume that a flip-in poison pill plan is triggered when the acquirer buys 30% of the target company’s stock.

Every shareholder, with the exception of the acquirer, is eligible to buy new shares at a reduced price after the trigger is triggered.

The purchasing company’s interest is eroded as the number of shareholders who buy additional shares increases. As a result, the bid will be significantly more expensive.

As additional shares enter the market, the value of the acquirer’s shares decreases, making the takeover effort more expensive and challenging.

A bidder may be hesitant to pursue a takeover if they are aware that such a strategy could be implemented.

Flip-in provisions are frequently made public in a company’s bylaws or charter, indicating its potential use as a takeover defence.

Turn the Poison Pill Over

If the hostile takeover attempt is successful, owners of the target firm might purchase shares of the acquiring company at a deep discount.

For example, a target firm shareholder may receive the right to buy its acquirer’s stock at a two-for-one discount, diminishing the acquiring company’s equity.

If the acquirer believes there will be a dilution of value after the acquisition, it may decide not to proceed.

Examples of Poison Pills

The poison pill was adopted by the board of Papa John’s (PZZA) in July 2018 to prevent expelled founder John Schnatter from regaining control of the company.

Schnatter was the company’s largest stakeholder, holding 30 percent of the company’s equity.

The company’s board of directors approved a Limited Duration Stockholders Rights plan—a poison pill provision—to thwart any potential takeover attempts by Schnatter.

The wolf-pack provision, as it was known, effectively doubled the share price for anyone who tried to acquire more than a specific percentage of the company’s stock without board consent.

The proposal would take effect if Schnatter and his affiliates increased their total ownership in the firm to 31 percent, or if someone purchased 15 percent of the common shares without the board’s approval, according to the New York Times.

The technique successfully made a hostile takeover of the company unappealing because Schnatter was excluded from the dividend distribution: a potential acquirer would have to pay twice the value per share of the company’s ordinary stock.

It stopped him from attempting to buy the company he started at market value in order to gain control of it.

Netflix (NFLX) announced in 2012 that its board of directors had approved a shareholder rights plan just days after Carl Icahn bought a 10% investment in the company.

Current shareholders can buy two shares for the price of one under the new plan, which stipulates that every new acquisition of 10% or more, any Netflix merger, sale, or transfer of more than 50% of assets permits existing shareholders to buy two shares for the price of one.

What Is the Purpose of Poison Pills?

When a corporation is threatened with a hostile takeover, it may employ the poison pill method to make itself less appealing to the possible buyer.

This strategy makes the acquiring firm or individual’s shares undesirable, or difficult to accept.

Poison pills also boost the cost of purchases greatly and offer significant disincentives to entirely prohibit such attempts.

The system protects minority shareholders and prevents the company’s management from changing hands.

What Are the Risks of Taking Poison Pills?

There are three primary drawbacks of taking poison tablets. Because stock values dilution occurs, shareholders must frequently purchase new shares to maintain parity.

Institutional investors are hesitant to invest in companies that have strong defences. Poison pills can help ineffective bosses stay in their jobs.

If this were not the case, outside venture investors might be able to purchase the company and increase its worth by hiring superior management.

What is a Poison Pill with a Flip-In Cap?

Allowing all shareholders, excluding the acquirer, to purchase additional shares at a discount is known as a flip-in poison pill technique.

While purchasing additional shares offers stockholders with immediate benefits, the practise dilutes the value of the acquiring company’s limited number of shares already owned.

This right to purchase is granted to shareholders before the takeover is completed, and it is usually activated when the acquirer obtains a particular percentage of the target company’s shares.

What is a Poison Pill that Flips Over?

If the hostile takeover attempt is successful, owners of the target firm might purchase shares of the acquiring company at a deep discount.

For example, a target firm shareholder may receive the right to buy its acquirer’s stock at a two-for-one discount, diminishing the acquiring company’s equity.

If the acquirer believes there will be a dilution of value after the acquisition, it may decide not to proceed.

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