how poison pills work
the poison pill is a tactic companies use to deter takeovers by unwanted companies often called a shareholder rights plan it is meant to frustrate creeping acquisitions of control in which the acquirer seeks to accumulate a controlling or dominant stake without negotiating with the board or offering the same deal to every shareholder because many shares come with ownership and voting rights it is possible to own enough to purchase a controlling amount of shares with voting rights so if one entity owns the right amount of shares their votes weigh more than those with fewer shares to prevent this the potential target creates a provision that prevents hostile takeovers by establishing a share ownership limit this provision may specify that if a single entity or person acquires a stake of 15 or more the company implements a share issuance or other measure that makes the hostile action ineffective or undesirable in a flip in all other shareholders become eligible to acquire additional shares for a large discount or free the party with the 15 stake is excluded from the stock issuance this increases the number of outstanding shares and dilutes that party s stake thus averting the takeover while takeovers are still commonplace hostile takeovers are not as common as they used to be because of tools like poison pills special considerationsproxy advisory firms glass lewis and international shareholder services traditionally opposed poison pills because of their potential to entrench managers unresponsive to shareholders as of 2022 iss guidelines called for poison pills to have a term of no more than three years and a trigger of no lower than 20 of shares outstanding 2 glass lewis generally opposes poison pills with case by case exceptions for those limited in scope and motivated by a particular threat or objective 3advantages and disadvantages of a poison pilla company s board has a fiduciary duty to protect the interests of all shareholders while an outsider seeking control may only wish or need to satisfy a minority to gain effective control through a tender offer a poison pill helps prevent majority control takeovers that disregard the interests of minority shareholders it also discourages vulture bids seeking to take advantage of a temporary decline in a share price for instance market declines at the outset of the covid 19 pandemic led hundreds of u s companies to adopt shareholder rights plans 4companies with poison pill defenses have tended to garner higher takeover premiums than those without them 5 industrial gasses supplier airgas which deployed a poison pill to resist a hostile takeover by rival air products and chemicals apd in a landmark legal battle sold four years later to air liquide for more than twice as much as air products offered 6by discouraging a motivated buyer from buying more company stock a poison pill will likely leave a share price lower than it would be otherwise at least in the short run poison pills can also shield underperforming board members from shareholder efforts to replace them the good news on that score is that replacing a company board in a proxy contest can make a poison pill disappear if the new board chooses to do so because poison pills discriminate against activist buyers and restrain trading in a company s stock they typically require justification and often have sunset provisions 7 a sunset provision is a clause that expires automatically at a certain date prevents majority control takeovers that don t consider minority shareholder interestsdiscourages vulture bids that want to benefit from temporary share price declinescome with higher takeover premiums than those without themleaves share price lowershields underperforming board members from efforts to replace themrequires justificationcomes with sunset provisionstypes of poison pillsmost poison pills are triggered by the accumulation of a company stake above a preset threshold these are known as flip in shareholder rights plans in contrast to the seldom used flip over ones this type of poison pill is just like a reverse takeover it occurs when a company allows itself to be acquired by another public company and then lets shareholders buy shares of the acquirer at a discount 8a dead hand or slow hand poison pill limits a future board s ability to remove that provision by specifying that it can only be canceled by a board majority consisting of current directors or the successors they choose delaware the corporate domicile state of two thirds of fortune 500 companies and most recent initial public offerings bars dead hand poison pills while georgia and pennsylvania courts have upheld them 910poison pills often include wolf pack clauses applicable to the aggregate holdings of shareholders acting in concert without expressly agreeing to do so for example hedge fund managers commonly accumulate separate stakes in companies pursuing a common activist agenda without communicating the intent 11examples of poison pillsthe poison pill tactic has been around since the 1980s when it was devised by new york law firm wachtell lipton rosen and katz amid a wave of hostile takeover and greenmail attempts by corporate raiders since rebranded as activist investors 12 courts have ruled that poison pills are a legitimate defense against such attempts to circumvent a company board s prerogatives 13in early april 2022 elon musk threatened social media giant x with a hostile takeover by disclosing that he purchased 9 of the company s shares x adopted a poison pill provision to prevent the takeover in mid april 2022 it used 15 as its ownership threshold which prevented anyone from taking over the company without bargaining for a fair value by the end of april the company agreed to a buyout by elon musk 1415musk ended up purchasing the company in october 2022 for 44 billion 16in july 2018 the board of restaurant chain papa john s pzza voted to adopt a poison pill to prevent ousted founder john schnatter from gaining control of the company schnatter who owned 30 of the company s stock was the company s largest shareholder 17to deter a takeover attempt by schnatter the board adopted a poison pill expiring after a year that would permit the company to sell its stock to shareholders for half its market price if schnatter and his affiliates increased their stake to 31 or if anyone else amassed a 15 stake as with all poison pills those triggering the provision would not be allowed to buy stock on the same discounted terms effectively diluting their stake 