Poison Pills Definition Example Top 6 Types With Reasons

What is a Poison Pill?

Let’s dig deeper to understand the history of this mechanism and the story behind its morbid name!

Reasons for Poison Pills

Source: FactSet

Main reasons for the adoption of poison pills

A “Poison Pill” is a popular defense mechanism for a “target company” wherein it uses shareholder’s rights issue as a tactic to make the hostile acquisition deal expensive or less attractive for the raiders. This strategy also acts as a tool to slow down the speed of potential hostile attempts in the future.

The Board of directorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. read more generally adopts them without the approval of shareholders. It also comes with a provision that the rights associated can be altered or redeemed by the board when required. It is to indirectly compel direct negotiations between the acquirer and the board to build grounds for better bargaining power.

It can pinch in two ways: They can either make an acquisition a very hard nut to crack, or they can have negative side-effects that unfold in various stages.

Common Types of Poison Pills

Poison Pill is an all-encompassing term, and there are various forms in which it is triggered in a practical corporate setting. Some of the widely used tools are:

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#1 – Preferred stock plans

Before 1984, when hostile takeover just jutted their ugly head, Preferred stock plans were primarily used as Poison pills. Under this plan, the company issues a dividend of preferred stock to the common shareholders, with voting rights. Preferred stockholders could exercise special rights whenever outsiders suddenly bought a large chunk of shares.

#2 – FLIP-IN

Post-1984, certain other methods also saw the light of the day. One such tactic is the Flip-in poison pillFlip-in Poison PillA flip in the poison pill strategy is one in which the target company’s shareholders, rather than the acquiring company’s shareholders, are allowed to buy the target company’s share at a discount, enabling the target company to dilute its share value.read more. When corporate raiders buy sizable holdings in a company, Flip in is one of the most preferred strikes back. Here the target company buys many shares at a discounted rate to counter the offer, which eventually leads to the dilution of control of the acquirer. E.g., if an investor buys more than 15% of the company’s stock, other shareholders from the bidder buy an increased number of shares. The greater the additional shares purchasedShares PurchasedA shares purchase agreement is a legally binding document depicting that the shareholder had bought the specified stock units from the company at a listed price for a certain period. Also, both the parties to the contract agree to the contractual terms and conditions.read more, the more diluted the acquirer’s interest. It also increases the cost of the bid. Once the bidder gets a hint that such a plan is being executed, he may become cautious and become discouraged to pursue the deal further. It may also be possible that the bidder then comes up with a formal offer to the board for negotiation.

#3 – FLIP-OVER

Flip-over is the opposite of Flip-in and happens when the shareholders choose to buy shares in the acquirer’s company after the merger. Let’s say the target company’s shareholders exercise the option of buying two-for-one shares in the merged company at a discount. This option usually comes with a pre-determined expiration date and no voting rights.

Diluting the acquirer’s interest makes the deal quite expensive and exasperating. If the acquirer backs off, the target company can also redeem those rights.

#4 – Back-end rights plan

Under this defense mechanism, the target company shuffles employee stock-option plansEmployee Stock-option PlansEmployee stock option plan (ESOP) is an “option” granted to the company employee which carries the right, but not the obligation, to buy a promised number of shares at a pre-determined price (known as exercise price). read more and designs them to become effective in the event of any unwelcome bid. It entails giving shareholders the privilege to obtain shares with a higher value if the acquiring company takes a majority stake. This way, the acquiring company would not quote a lower price for the shares. However, if the acquirer is ready to offer a greater price, the Back-end rights plan falls through under exceptional circumstances. It is nothing but a move to deter the acquisition.

#5 – Golden Handcuffs

We all agree that employees are the biggest assets of a company. Golden handcuffsGolden HandcuffsGolden Handcuff is referred to the employer offering a valuable incentive to the employee to bind them and stay in the company for an extended period. For an employee to stay with an employer, the latter should provide a financial incentive, and the former should be in a position to accept the incentive.read more are nothing but various incentives offered to the crème-del-a-crème of the company to ensure that they stay on. Usually, Golden handcuffs are issued in deferred compensationDeferred CompensationDeferred compensation is an arrangement whereby a portion of the income of an individual is set aside and paid at a later date. It is generally done in order to defer the payment of taxes as the amount contributed towards such deferred compensation is in most cases is not taxed until the income is actually paid off. Examples include employee stock options, pension, and retirement plans.read more, employee stock options (ESOPs), or restricted stock, which can be earned after the employee reaches a particular performance threshold.

However, not many of us know that Golden handcuffs can also be used as an anti-takeover mechanism. When an unsolicited bid happens, this Poison Pill gets triggered. The key staff becomes vested in stock optionsStock OptionsStock options are derivative instruments that give the holder the right to buy or sell any stock at a predetermined price regardless of the prevailing market prices. It typically consists of four components: the strike price, the expiry date, the lot size, and the share premium.read more, and their golden handcuffs are removed. These employees, some with extremely rich experience and insight, are now free to leave the company. Therefore, the acquirer will lose key executives of the target company, which will make the path difficult for him to tread.

#6 – Voting Plans

Designed on the same lines as the Preferred Stock Plan and Flip-in, this tactic involves voting rights as a tool of controlling mechanism. When an investor obtains a substantial block of shares, preference shareholders (apart from the large block holder) become authorized to super-voting rights. It is difficult and unattractive to obtain voting control by the bulk share purchaser.

Trends of poison pills adopted according to market cap (till 2014)

Source: The University of British Columbia

History of Poison Pill

Every phenomenon in the world has a history behind it, and Poison Pills is no exception. The blatant occurrences of hostile takeovers and defense mechanisms were in full momentum in the 1980s. Hostile takeovers became the order of the day. In the 1970s, corporate raiders like T. Boone Pickens and Carl Icahn sent chills down the spine of many corporate boards. There was no legalized defense tactic in place. In 1982, M&A lawyer, Martin Lipton of Wachtell, Lipton, Rosen & Katz, came as a knight in shining armor and invented the “poison pill” defense to prevent hostile corporate takeovers. According to experts, this was the most significant legal development in corporate law in the 20th century.

The legality of poison pills had been vague when they first came in the early 1980s. However, the Delaware Supreme Court advocated poison pills as a valid defense tactic in its 1985 decision in Moran v. Household International, Inc.; many jurisdictions outside the U.S. consider poison pills as illegal and place constraints on their applicability.

So what’s the story behind such an awkward name? It dates back to the tradition of espionage prevalent during the monarchical era. Whenever an enemy caught a spy, he immediately swallowed a cyanide pill to escape interrogation and revelation of truth. Poison Pill owes its name to this practice.

Examples of Poison Pills

#1 – Netflix

Carl Icahn, an institutional investor, caught Netflix off-guard in 2012 by acquiring a 10% stake. The latter responded by issuing a shareholder’s right plan as a “Poison Pill,” a move that irked Carl Icahn to no end. A year later, he cut his holding to 4.5%, and Netflix terminated its right issue plan in December 2013

source: money.cnn.com

#2 – GAIN Capital

When FXCM Inc planned to acquire GAIN Capital Holdings, Inc. in April 2013, GAIN responded by triggering a “poison pill.” Rights were decided to be distributed to the common shares at the rate of one-for-one of the company held by stockholdersStockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company’s owners, but their liability is limited to the value of their shares.read more. Upon the occurrence of an unforeseen event, each right would authorize stockholders to buy one-hundredth of a share of a new series of participating preferred stockParticipating Preferred StockParticipating preferred stock are entitled to receive fixed dividends plus additional dividends where an additional dividend is a positive difference between the dividends paid to the common stockholder and the fixed amount which is set to be paid to that preferred stockholder making the total dividend amount paid to participate preferred stockholder equal to that of the common stockholder.read more at an exercise price of $17.00, which was later raised.

source: Leaprate.com

#3 – Micron Tech

The Board of Directors of Micron Technology Inc., the largest US memory chipmaker, adopted a “Poison Pill” strategy in the apprehension of a hostile takeover. The tactic was a rights issueRights IssueThe term “right issue of shares” refers to the offering of shares to all existing Equity or Preference shareholders of the Company in proportion to their current shareholding in the Company.read more that would be triggered if an individual or group acquired 4.99% or more of the company’s outstanding stock.

source: Bloomberg.com

#4 – Pier 1 Imports

The agreement entitled every common stockholder the right to buy a fraction of junior preferred stock at the price of $17.50. The preferred sharesThe Preferred SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more would have similar voting terms to common stock, diluting the control of any shareholder capturing a big stake. More recently, in September 2016, Pier 1 Imports Inc resorted to the Poison Pill measure when hedge fund firm Alden Global Capital LLC disclosed a 9.5% stake in the former.

source: marketwatch.com

Advantages and Disadvantages of Poison Pill

Shareholder Value Lost Due to Poison Pills

Source: Harvard Law School Forum

Always bitter or sometimes sweet?

Hostile takeovers and defense mechanisms cannot be classified in black and white compartments. There are certain gray areas also. Not all takeovers are bad; neither are all takeover defense mechanisms in the company’s best interests. Some of these investors have significant knowledge of the industry and company affairs, sometimes much better than its management itself. These days, corporate raids or hostile takeovers have manifested themselves in a relatively constructive form called “Investor Activism” these days. Any act of investors to influence corporate paths or shareholders’ long-term goals is viewed as activism.

According to S&P Capital IQ, “The agendas vary among investors and focus on specific areas, including cost reductions, reorganizationsReorganizationsReorganization refers to the legal process of modifying, merging, or acquiring a company and its assets. Typically undertaken to solve low-profit margins, reasons for revamping vary as per the firm’s needs. For instance, in 2017, Wall Street Journal had announced a major editorial reorganization to help the 128-year-old newspaper adapt to the requirements of digital news reporting.read more, corporate spin-offs, revamped financing structures, greater leverage, and more shareholder-oriented uses of cash and liquidity to realize higher enterprise valueEnterprise ValueEnterprise value (EV) is the corporate valuation of a company, determined by using market capitalization and total debt.read more in the public markets.”

S&P Capital IQ stated that; from 2005 to 2009, 89 activist actions occurred, while in the past five years, from 2010 to 2014, 341 actions took place. There has been a volume increase each year since 2010, and this trend has sustained itself strongly in 2015. Thus we can see that the practice that took the corporate world by storm in the 1980s is relevant even today.

Source: S&P Capital IQ based on data (companies with individual market capitalizations of $1 billion or more) from 1 Jan 2005 to 19 June 2015

Before ascertaining whether Poison Pills are doing any good to the company, we need to understand that any company has many stakeholders affected differently during a potential takeover. The board of directors has different financial stakes and responsibilities toward the company and the shareholders. Shareholders have a financial interest in maximizing the value of the company’s shares. At the same time, corporate executives who also have ownership in the company may either stand to gain or lose from the takeover.

Other company employees, usually at the lower and middle levels, stand to lose most of the time due to mergers. News of acquiring companies announcing mass layoffs during mergers is also not unheard.

Poison Pills Video

Conclusion

It is difficult to conclude whether a Poison Pill is beneficial or not. It all depends on the long-term goals of both companies. Understanding how a company responds to hostile takeoversHostile TakeoversA hostile takeover is a process where a company acquires another company against the will of its management.read more with a poison pill or other defense can reveal great truths about how it tackles critical issues about the management and itself.

What is a Poison Pill?#

Reasons for Poison Pills#

Common Types of Poison Pills#

#1 – Preferred stock plans#

#2 – FLIP-IN#

#3 – FLIP-OVER#

#4 – Back-end rights plan#

#5 – Golden Handcuffs#

#6 – Voting Plans#

Trends of poison pills adopted according to market cap (till 2014)#

History of Poison Pill#

Examples of Poison Pills#

#1 – Netflix#

#2 – GAIN Capital#

#3 – Micron Tech#

#4 – Pier 1 Imports#

Advantages and Disadvantages of Poison Pill#

Shareholder Value Lost Due to Poison Pills#

Always bitter or sometimes sweet?#

Poison Pills Video#

Conclusion#

Recommended Articles#