From golden parachutes to back-end rights plans, here are the top five poison pills in the business world.
In the business world, little is more important than protecting your company at any cost. Sometimes, those costs can be very high, demanding that you give up your business altogether. To prevent that from happening, most companies employ a tactic referred to as poison pills.
A poison pill is a shareholder plan to discourage buyouts, takeovers and acquisition attempts by activist investors. For instance, in 2012, Netflix inserted a “poison pill” clause into its corporate charter that would have made a hostile takeover prohibitively expensive, thus keeping it safe from a takeover by activist investor Carl Icahn.
However, poison pills don’t always have to be so dramatic. Sometimes, they can be much more subtle and just as effective at scuttling a deal. Here are the five biggest types of poison pills in the business world:
1. Flip-in
These are clauses that allow a company’s board of directors to issue new shares of stock to existing shareholders at a discount if someone tries to acquire a large stake in the company. The idea of a flip-in poison pill is to make a hostile takeover much more difficult and costly for the buyer by diluting the potential acquirer’s stake.
For example, let’s say Company A has 50% of the shares of Company B and wants to buy the rest. Company B has a flip-in provision that allows any shareholder with at least 10% of the shares to purchase new shares at half price if Company A buys more than 50% of the company. So, suppose Company A tries to buy 51% of the shares. In that case, the other shareholders can effectively dilute Company A’s ownership by buying new shares at half price, making it much more challenging (and expensive) for Company A to get a majority stake.
2. Flip-over
In a flip-over provision, the existing shareholders of the target company in a takeover attempt can buy shares in the acquiring company at a discounted price. This devalues the stock price of the acquiring company, thus discouraging them from taking over the target company. Essentially, the takeover attempt is literally “flipped over”.
Let’s take a flip-over provision in a merger agreement as an example. Assume that Company A wants to buy Company B, but Company B doesn’t want to be bought. To ward off Company A, Company B might agree to a flip-over provision that would allow Company B’s shareholders to purchase new shares of Company A at half price if it ever acquires more than 30% of the company.
3. Preferred stock plans
Preferred stock is a type of stock that gives its holders certain privileges, such as redeeming dividends and assets at the highest possible share price they have paid for the common stock in case of a takeover. Secondly, they are even given special voting rights. The holders of preferred stock (except for the acquirer) would have greater voting power than the holder of common stock, making it less appealing for an outsider to take over the company. Overall, the goal is to dilute the total number of shares available to the acquiring company.
4. Golden parachutes
A golden parachute comprises a host of benefits, like a hefty severance package, designed to keep key executives at a company during a change in ownership. For instance, in the case of a successful takeover, the original executives might receive a lump sum payment, stock compensation, ongoing insurance and pension benefits, etc., if they are terminated. Golden parachutes are often used as poison pills because they make it much more expensive for a potential acquirer to replace key personnel.
5. Back-end rights plan
As part of the back-end rights plan, existing shareholders of a company can choose to sell their securities in return for cash. Typically, during a merger or acquisition, the acquiring company will buy the majority of shares and gain significant voting rights. Then, it would attempt to force others to give up their stake for a lower share price. However, to make that unappealing, the back-end rights plan gives shareholders the option to sell their securities for cash for a high bid externally. This way, if an acquirer does try to take over the company, they will have to quote a much higher price.
Poison pills can help you keep your company safe from a hostile takeover. However, they are not a fail-safe tactic; after all, if the acquiring company wants your company enough, it might be willing to undertake any expense for it. In times like those, your best bet might be negotiating a deal that benefits everyone.
Also read:
- Decoding the Hard-To-Swallow Pill in the Business World: What Is a Poison Pill Strategy?
- Exit Strategies for Startup Founders
- How to Communicate with Your Investors
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