Peggy James is a CPA with 8 years of experience in corporate accounting and finance who currently works at a private university.

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What Is a Poison Pill?

The term poison pill refers lớn a defense strategy used by a target firm khổng lồ prevent or discourage a potentialhostile takeoverby an acquiring company. Potential targets use this tactic in order to lớn make them look less attractive sầu lớn the potential acquirer. Although they"re not always the first—và best—way to defkết thúc a company, poison pills are generally very effective.

A poison pill is a defense tactic utilized by a target companyto prsự kiện or discouragehostile takeoverattempts. Poison pills allow existing shareholders the right lớn purchase additional shares at a discount, effectively diluting the ownership interest of a new, hostile tiệc ngọt.Poison pills often come in two forms—the flip-in và flip-over strategies.

How Poison Pills Work

Takeovers are fairly common in the business world, where one company makes an offer to assume control over another. Larger companies tkết thúc to take over smaller ones if they want lớn get inkhổng lồ a new market, when there are operational benefits by combining both entities, or when the acquirer wants to lớn eliminate the competition. Takeovers, though, aren"t always harmonious & become hostile when the target doesn"t entertain or want khổng lồ be taken over.

When a company becomes the target of a hostile takeover, it may use the poison pill strategy to lớn make itself less attractive lớn the potential acquirer. As the name indicates, a poison pill is analogous khổng lồ something that"s difficult to swallow or accept. A company targeted for an unwanted takeover may use a poison pill lớn make its shares unfavorable to the acquiring firm or individual.

Poison pills also significantly raise the cost of acquisitions & create big disincentives khổng lồ deter such attempts completely.

The mechanism protects minority shareholders và avoids the change of control of company management. Implementing a poison pill may not always indicate that the company is not willing khổng lồ be acquired. At times, it may be enactedto get a higher valuation or more favorable terms for the acquisition.

Since shareholders—who are the actual owners of a company—can vote by majority to favor the acquisition, the target company management deploys a poison pill, which is usually aspecially designed shareholder rights plan with certain conditions drafted specifically to lớn thwart attempted takeovers.

Special Considerations

The poison pill tactic has been around since the 1980s and was devised by New York-based legal firm Wachtell, Lipton, Rosen, and Katz. The name comes from the poison pill spies carried in the past to lớn avoid being questioned by their enemies in the sự kiện they were captured. It was designed as a way to lớn prevent an acquiring company from buying a majority nói qua in the potential target or from negotiating with shareholders directly at a time when takeovers were becoming very frequent and comtháng.

Types of Poison Pills

There are two types of poison pill strategies—the flip-in và flip-over. Of the two types, the flip-in variety is more commonly followed.

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Flip-in Poison Pills

A flip-in poison pill strategy involves allowing the shareholders, except for the acquirer, to lớn purchase additional shares at a discount. Though purchasing additional shares provides shareholders with instantaneous profits, the practicedilutes the value of the limited number of shares already purchased by the acquiring company. This right to lớn purchase is given khổng lồ the shareholders before the takeover is finalized và is often triggered when the acquirer amasses a certain threshold percentage of shares of the target company.

Here"s an example. Let"s say a flip-in poison pill plan is triggered when the acquirer purchases 30% of the target company’s shares. Once triggered, every shareholder—excluding the acquirer—is entitled to buy new shares at a discounted rate. The greater the number of shareholders who buy additional shares, the more diluted the acquiring company"s interest becomes. This makes the cost of the bid much higher.

As new shares make way lớn the market, the value of shares held by the acquirer reduces, thereby making the takeover attempt more expensive and more difficult. If a bidder is aware that such a plan could be activated, they may be inclined not to lớn pursue a takeover. Suchprovisions of a flip-in are often publicly available in a company"s bylaws, or charter, và indicate their potential use as a takeover defense.

Flip-Over Poison Pills

A flip-over poison pill strategy allows stockholders of the target company khổng lồ purchase the shares of the acquiring company at a deeply discounted price if thehostile takeover attempt is successful. For example, a target companyshareholder may gain the right to buy the stoông chồng of its acquirer at a two-for-one rate, therebydiluting the equity in the acquiring company. The acquirer may avoid going ahead with such acquisitions if it perceives a dilution of value post-acquisition.

Examples of Poison Pills

In July 2018, the board of restaurant chain Papa John’s (PZZA) voted to adopt thepoison pillto lớn prsự kiện ousted founder John Schnatter from gaining control of the company. Schnatter, who owned30% of the company’s stochồng,was the largest shareholder of the company.

To repeal any possible takeover attempts by Schnatter, thecompany"s board of directors adopted a Limited Duration Stockholders Rights plan—a poison pill provision. Dubbed the wolf-pachồng provision, It essentially doubled the chia sẻ price for anyone who attempted to amass more than a certain percentage of the company’s shares without board approval.

The Thủ đô New York Times reported that the plan would take effect if Schnatter & his affiliates raised their combined stake in the company to lớn 31%, or if anyone purchased 15% of the common stock without the board’s approval.

Since Schnatter was excluded from the dividend distribution, the tactic effectively made a hostile takeover of the company unattractive: the potential acquirer would have lớn pay twice the value per mô tả of the company"s common stoông chồng. It prevented hyên ổn from trying to take over the company he founded by buying its shares at market price.

In 2012, Netflix (NFLX) announced that a shareholder rights plan was adopted by its board just days after investor Carl Icahn acquired a 10% stake. The new plan stipulated that with any new acquisition of 10% or more, any Netflix merger, sales, or transfer of more than 50% of assets, allows for existing shareholders lớn purchase two shares for the price of one.

Stoông xã values become diluted, so shareholders often have sầu lớn purchase new shares just to lớn keep even. Institutional investors are discouraged from buying inkhổng lồ corporations that have aggressive sầu defenses. Ineffective sầu managers can stay in place through poison pills. If that weren"t the case, outsideventure capitalistsmight be able lớn buy the firm và improve sầu its value with better managing staff.

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