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A Complete Guide to Poison Pill Strategy

A poison pill is a defense tactic utilized by a target company to prevent or discourage hostile takeover attempts. Poison pills allow existing shareholders the right to purchase additional shares at a discount, effectively diluting the ownership interest of a new, hostile party.

What is Poison Pill Strategy?

 A poison pill strategy is a corporate defense tactic used to protect a corporation from hostile takeover attempts by enabling its shareholders to purchase additional shares of stock at a discounted price. This action is intended to dilute the ownership of any new party that makes a hostile takeover bid for the company. The poison pill may be one of several stop-gap measures designed to ward off a hostile takeover, including a stockholder rights plan, or “right to go” (RTS) plan, which ensures the corporation’s shareholders are paid a certain premium before a hostile takeover can proceed.
 The term comes from the “little pills” a dog owner might leave out for the family pet in an attempt to thwart an unwelcome visitor who has entered the house.

How does Poison Pill Strategy Work?

A poison pill strategy is a defense tactic used by a corporation in reaction to a potential hostile takeover that involves the distribution of certain rights and obligations to the corporation’s shareholders. The rights enable shareholders to purchase additional shares of stock at a discounted price.

Purpose of Poison Pill Strategy

The purpose of a poison pill strategy is to dilute the value of a hostile bidder’s stock holdings in the company, and thereby make the acquisition prohibitively expensive. A poison pill strategy is most useful when a hostile takeover bid is hostile and when the company’s incumbent directors believe that the bid is not in the best interest of current shareholders.

1) A corporation defends itself against a hostile takeover attempt by preparing a poison pill strategy. This might be a rights plan or a convertible preferred stock plan.
2) The target corporation’s board of directors decides to implement the poison pill strategy.
3) The corporation announces the poison pill strategy to the SEC, current shareholders and the public.
4) A potential hostile bidder receives notification of the poison pill strategy.
5) After the potential hostile bidder receives notification of the poison pill strategy, it decides to halt its acquisition attempt in light of the poison pill strategy’s defensive tactics. This is because the hostile bidder believes that it cannot achieve the desired takeover price without incurring excessive costs.

Key Takeaways


When implemented, poison pills often operate in a matter of days, rather than months. However, just because a poison pill is implemented does not mean that the hostile stakeholder will abandon its takeover bid because of the defensive tactic. The potential hostile bidder may decide to drop its bid, raise its bid, or seek a friendly merger or proxy contest to oust the incumbent board. However, the poison pill substantially limits the potential hostile bidder’s options

What is a Buyout Strategy?

A buyout is a transaction in which an acquirer obtains control of one or more businesses from an incumbent manager, typically one that wishes to exit its ownership. A buyout thus has the opposite effect of a sale of the business, which transfers ownership from the acquirer to the incumbent manager or management group.

How does a Buyout Strategy Work?

A buyout is typically structured as an asset purchase, so that the target’s existing stockholders maintain ownership of the business. The acquirer buys the assets and then liquidates the target’s liabilities to pay its shareholders.

 In a management buyout, an acquirer only purchases a business from management, and so does not buy all the shares of the company. Management buyouts of this sort are often used by directors to gain a financial interest in the company which they control, as well as to free themselves from the bonds of a current corporate structure. Management buyouts are also often used in the event of a hostile takeover in which a corporation is purchased from under a company’s current managers through a leveraged buyout.

A public to private buyout occurs when a private equity firm purchases a business with the intention of a further sale to a Company whose stock is publicly traded.

What is a Leveraged Buyout?

 A leveraged buyout is a financial transaction in which an entity (the acquirer) obtains control over another entity (the target), but the financial obligations of the target do not necessarily become the financial obligations of the acquirer. As a result of the acquisition, the shareholders of the target receive payment, but the acquirer must also borrow money to finance the acquisition.

A leveraged buyout occurs when an acquirer purchases a publicly held company using primarily borrowed money. The acquirer then “leverages up” its investment by taking on a significant amount of liabilities. The target company’s assets are used to secure the acquisition, and they are often transferred to a new entity that is created by the acquirer for this purpose.

Poison Pill Strategy

Poison pill strategy is often confused with a potential hostile bidder’s takeover defense tactic of dropping its bid after the corporation’s implementation of a poison pill. Although the poison pill and the hostile bidder’s decision not to proceed after a poison pill is announced are often concurrent, they should not be confused to be synonymous. After being notified of a poison pill, the potential hostile bidder may determine that the corporation’s implementation of a poison pill is a good deal, or it may choose to let its bid expire due to the corporation’s implementation of a poison pill, but this decision is independent and distinct from the poison pill itself.

Stockholder Rights Plan

Although securities laws governing rights plans are similar to those governing poison pills, rights plans have a somewhat different economic effect on the market for the company’s stock compared to poison pills. A conventional poison pill may be more effective because it gives shareholders the opportunity to acquire the right to purchase additional shares of a company, rather than issuing new shares of the company to them. This is because issuing new shares substantially increases the number of shares outstanding, and dilutes the value of existing shares.

The main difference between the two types of plans is that, under the terms of a rights plan, a shareholder who acquires additional shares benefits from any increase in the value of the company, whereas a shareholder who wishes to implement a poison pill is prevented from profiting from an increase in the value of the company. To compensate for the issuance of a rights plan, shares typically increase in value by more than the cost of such an issuance. This is why rights plans are favored over poison pills when a significant increase in the company’s share price is expected in the foreseeable future.

Common Stock Or  Preferred Stock

A common stock is a type of corporation stock which gives the holder no special rights in the management of the company, except the right to vote on policy matters. A preferred stock is a type of stock which entitles the holder to a set of specified cash payments before any payments can be made to holders of common stock. The specific terms of a particular series of preferred stock are filed as a registration statement on a Form S-4 (or formerly, a Form S-8) with the U.S. Securities and Exchange Commission (SEC). 

The Role of Institutional Investors

A potential hostile bidder’s decision to drop a bid after a poison pill is implemented is based on the belief that it cannot afford the price sufficiently to bid for the company without the costs incurred by the hostile tactics. Thus, it should be seen that a poison pill is not an effective deterrent of a hostile takeover if a potential hostile bidder is certain of its stock price expectation. This is especially so in the case of strategic buyers that have contractual commitments to invest in the target corporation. The decision to drop a bid after a poison pill is implemented can be explained by the fact that financial institutions, institutions and investment advisors who provide financing to a potential hostile bidder are more involved in the decision making process and have the ability to control their clients’ actions.

Information Or  Price Revealing Strategy

The primary goal of implementing a poison pill strategy is to provide information to potential acquirers regarding the deterrent cost of the pill. Thus, the decision not to proceed with the proposed takeover cannot be explained by whether the pill was actually implemented, but rather by the costs of implementing the pill. A poison pill is a valid defensive tactic for a corporation if a potential hostile bidder believes that the pill is defensive in nature. Thus, a potential hostile bidder’s decision to drop its takeover bid can be explained by the fact that the hostile bidder does not believe that the pill is defensive and does not represent a real threat. Thus, a hostile bidder’s decision to drop its takeover bid after a poison pill is implemented can be explained by the fact that it does not believe the poison pill is so prohibitive that the hostile bidder is better off not proceeding with the bid.

Incumbent Management’s Action Or Inaction

The effect of a poison pill on a corporation’s share price reflects the outcome of an implicit contest for control of the corporation. Thus, the implementation of a poison pill is a direct response to a potential hostile bidder’s first tender offer. However, a corporation’s response to an unfriendly acquisition is likely to be a combination of tactics. Thus, the response to an unfriendly acquisition may be to implement a poison pill and negotiate with the bidder.

Rational Choice Theories

A potential hostile bidder’s decision to not proceed with a bid after a poison pill is implemented is based on the bidder’s ability to finance the takeover. Thus, the implementation of a poison pill is a direct response to a potential hostile bidder’s first tender offer. A corporation’s response to an unfriendly acquisition is likely to be a combination of such tactics. Thus, the response to an unfriendly acquisition may be to implement a poison pill and negotiate with the bidder. A potential hostile bidder’s decision to drop the bidder’s bid after the corporation’s implementation of a poison pill is based on the bidder’s beliefs that their stock price expectation is not met by the corporation’s implementation of the pill.

Creditor’s Rights In A Proprietary Bankruptcy Process

The probability that a corporation will declare bankruptcy following the implementation of a poison pill depends on the corporation’s perceived value and its liquidity. Thus, the use of a poison pill is primarily used by organizations that are unable to attract investors.

A corporation’s decision to adopt an antitakeover measure or not is based on whether a potential hostile bidder’s actions are detrimental to the corporation’s success. Thus, it is difficult to identify a catalyst for the implementation of a poison pill. This decision depends on the hostile bidder’s actions.

The decision to adopt a poison pill or not is based on whether the corporation’s top management perceives that the use of the pill will raise the corporation’s credibility and value in the eyes of the financial markets. Thus, the use of the poison pill is primarily used by a corporation that cannot attract investors.

There are several factors which can affect whether a poison pill will be adopted by corporations. An increase in the takeover premium decreases the likelihood of the adoption of a poison pill. However, an increase in the probability of a change of control increases the likelihood of the adoption of a poison pill. The likelihood of a poison pill being adopted increases as target leverage increases. The use of a poison pill decreases as external financing decreases.

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