What is the defense of “poison pills”?

On Friday, Twitter responded to Elon Musk’s bid to buy the company for more than $43 billion with a corporate tool known as the poison pill, a defensive strategy familiar to boards that attempts to prevent takeovers but less familiar to ordinary investors.

This defense mechanism was developed in the 1980s as corporate leaders, in the face of corporate raiders and hostile takeovers, attempted to defend their business from being taken over by another corporation, person or group.

A toxic pill is a maneuver that makes a company less acceptable to a potential buyer by making it more expensive for the buyer to buy the target company’s stock above a certain threshold.

“The whole point is to make the board’s offer more attractive to the buyer,” said Carlis Chatman, associate professor of law at the University of Washington and Lee University.

The strategy also gives the company more time to evaluate the offer and can give the board of directors leverage in trying to force direct negotiations with the potential buyer.

Formally known as an equity plan, the toxic pill can appear in a company’s charter, bylaws, or exist as a contract between shareholders.

There are different types of poison pills, said Ann Lipton, associate professor of law at Tulane University, but they usually allow some shareholders to buy additional stock at a discount.

The only contributor who was prevented from making these discount purchases was the person who released the poison pill. It is triggered when a person, usually a buyer, reaches a threshold for the number of shares he or she owns. If they get this far, their shares are suddenly diluted as other shareholders make discounted purchases.

Securities experts say investors rarely attempt to breach the toxic pill’s threshold, although there are exceptions.

Pizza chain Papa John’s adopted a poisonous bean in July 2018 in a rare case for a company trying to prevent its founder from taking over. After using racial slurs on a conference call and causing a stir, the company’s founder, John Schnatter, resigned as chairman of the company’s board that year, owning 30 percent of its stock at the time.

The Poison Pill would have allowed shareholders to buy shares at a discount if Schnatter, his family members or friends raised their stake in the company to 31 percent or if anyone else bought 15 percent of the shares without board approval. The dispute ended in a settlement in March 2019.

In the case of Twitter, the pill would flood the market with new shares if Mr. Musk, or any other individual or group working together, buys 15 percent or more of Twitter shares. This would immediately dilute Mr. Musk’s stake and make it more difficult to buy a large part of the company. Mr. Musk currently owns more than 9 percent of the company’s stock.

Ms Lipton said the company could be limited by the cap set in its charter on the number of shares it is allowed to use. But she said that even if it gets to that limit, the company has other options to make the purchase unattractive.

Poison pills can also be evaded if the buyer or shareholders sue the company for breach of its fiduciary duties. But Lipton said the courts had shown an “incredible reluctance” to intervene.

“Boards of directors have a great deal of leeway to judge what is in the best interests of shareholders, particularly if they are made up of independent board members,” she said. Boards often use toxic pills temporarily so they can consider their options more time.

Very, according to Professor Chatman. She said hostile takeovers are not as common as they were in the 1980s because potential acquirers now assume that companies have provisions for toxic pills.

Netflix successfully fended off billionaire investor Carl Icahn in November 2012, using a poison pill that would make it more expensive for Mr. Icahn, or another person or group, to accumulate more Netflix stock if they acquired 10 percent of the company without the approval of its board of directors. .

Almost a year later, in October 2013, Men Wearhouse survived a takeover attempt by Jos. (Then Men Wearhouse acquired Jos. A. Bank in March 2014, and the owners of both companies filed for bankruptcy in August 2020).

In September 1985, following rumors that consumer goods company Philip Morris was targeting her, McDonald’s said it had adopted a poison pill plan to prevent “arbitrary seizing tactics.” (The company said the plan was not adopted in response to any known bid.) A few years later, The Walt Disney Company announced that it had adopted an offer, calling it a “sound and reasonable means of protecting the interests of all shareholders.”

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