What is a ‘poison pill’ defense?

On Friday, Twitter responded to Elon Musk’s offer to buy the company for more than $43 billion with a corporate tool known as a poison pill, a defensive strategy familiar to boardrooms trying to stave off takeovers but less familiar to insiders. common investors.

This defense mechanism developed in the 1980s when company leaders, faced with corporate raiders and hostile takeovers, attempted to defend their businesses from being acquired by another company, person, or group.

What is a poison pill?

A poison pill is a maneuver that typically makes a company less acceptable to a potential acquirer by making it more expensive for the acquirer to buy shares of the target company above a certain threshold.

“The goal is to make the board’s offer more attractive to the acquirer,” said Carliss Chatman, an associate professor of law at Washington and Lee University.

The strategy also gives the company more time to evaluate an offer and can give the board leverage to try to force a direct negotiation with the potential acquirer.

What is really a poison pill?

A poison pill is officially known as a shareholder rights plan, and it can appear in a company’s bylaws or bylaws or exist as a contract between shareholders.

There are different kinds of poison pills, but they usually allow certain shareholders to buy additional shares at a discounted price, said Ann Lipton, an associate professor of law at Tulane University.

The only shareholder who cannot make these discount purchases is the one who activates the poison pill. It is triggered when a person, usually the acquirer, reaches a threshold of how many shares he owns. If they hit that threshold, the value of their shares is suddenly diluted as other shareholders buy at a discount.

Securities experts say investors rarely try to break the poison pill threshold, though there are exceptions.

Pizza chain Papa John’s adopted a poison pill in July 2018 in a rare case of a company trying to stop its founder from taking control. Founder John Schnatter walked out after a report that he had used a racial slur on a conference call, a statement he later said in court had been misconstrued. He owned 30 percent of its shares at the time.

The poison pill would have allowed shareholders to buy shares at a discount if Schnatter, his family or friends increased their stake in the company to 31 percent or if someone else bought 15 percent of the stock without board approval. The dispute ended with a settlement in March 2019.

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

Are there limits to using a poison pill?

Ms. Lipton said that a company could be limited by the cap in its bylaws on the number of shares it can issue. But even if she has hit that ceiling, she said, a company has other options to make the purchase unattractive.

And poison pills could also be evaded if the acquirer or shareholders sue the company for violating their fiduciary duties. But, Lipton said, the courts have shown an “incredible reluctance” to interfere.

“Boards have a lot of wiggle room to judge what is best for shareholders, particularly if they are made up of independent directors,” he said. Boards often implement poison pills on a temporary basis so they can consider their options earlier.

Are poison pills effective?

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

When else have poison pills been used?

Netflix successfully fended off billionaire investor Carl Icahn in November 2012, using a poison pill that would have made it more expensive for Mr. Icahn, or any other person or group, to amass more Netflix stock if they acquired 10 percent of the stock. business. without the approval of the board of directors.

Almost a year later, in October 2013, Men’s Wearhouse survived a takeover attempt by Jos. A. Bank Clothiers after he adopts a poison pill. (Men’s Wearhouse later acquired Jos. A. Bank in March 2014, with the owner of both companies filing for bankruptcy in August 2020.)

In September 1985, following rumors that it was being targeted by consumer goods company Philip Morris, McDonald’s Corporation said it had adopted a poison pill scheme to prevent “abusive acquisition tactics”. (The company said the plan was not adopted in response to any known offers.) A few years later, the Walt Disney Company announced that it had adopted one, calling it “a sound and reasonable means of safeguarding the interests of all shareholders.”