What the heck is a poison pill re: companies

“Last week, Yahoo adopted a poison pill with a 15 percent trigger, but said that the shareholder rights plan was not adopted in response to any specific attempt to acquire the company.”

  • Yahoo business news

I know that this has something to do with preventing a hostile takeover, but other than that I’m clueless.

A “poison pill” is simply a plan a corporation puts in place to make a hostile takeover more difficult. One common scenario is where the Board of Directors authorizes the sale of X number of shares of stock should someone try to take over the company against the wishes of the Board.

For a simplified example, say DrJackson Corp. has 1000 shares of stock outstanding @ $10 per share. All you need to do to take over my company is come up with $5010 and convince people holding 501 shares to sell. That would give you 50.1% of the vote and thereby control of the company. You elect your own Board, fire me, take over, etc.

In order to prevent that, my board has previously authorized the company to sell 1,000,000 additional shares @ $10 each should someone attempt to buy controlling interest in our company. Now you have to come up with $5,005,010 to buy over half my stock, and convince people holding 5,000,501 shares to sell. The additional shares may be common stock (in which case my dividend and shareholder equity just got shot to hell) or a separate class of stock which does not receive dividends. As long as it is voting stock this type poison pill can work. Apparently, Yahoo’s plan kicks in when one person (or one entity, or one group) buys 15% of Yahoo’s outstanding shares.

Not to say it’s right or even in the common stockholders best interest, but that’s one way it could work.

A hostile takeover usually results due to an undervaluation of a public company’s shares in comparison to the value which the prospective purchaser views the company. The classic 80s takeover usually meant canabalizing an inefficient company and selling off the parts for more than you paid. In a very simple example, consider a long standing company who’s land holdings have appreciated over the years but are not reflected in its share price because the appreciation hasn’t affected profits. There are of course other reasons why the purchaser may value a company higher than the market such as being a competitor or having particular synergies with their company.

This would seem to be a good thing for shareholders, they get to cash out at the best price. Laws have developed to require disclosure by the purchaser when they have acquired a certain number of shares, not coincidentally I believe this is 15%. This lets everyone know the shares are in play and drives the price up closer to the value the purchaser places on them. In one disagreement I have with the good doctor, you generally cannot get away with only purchasing 51% in a hostile takeover. While I can’t recall the exact mechanism the purchaser usually has to make an offer to acquire 100% of the shares.

Management may look at the offer and recomend against. On the purely legitimate side they might feel that the offer is too low and oppose the proposed takeover hoping to bring in other bidders ande drive the price up or even counter with their own takeover bid.

Management might also be concerned with their own jobs, their employees jobs, their emotional attachment to the company or even their own honest expectation that the shareholders will benefit more in the long term if the company continues under their management. Because of this they will try to take steps to make the company less attractive for a takeover. The company with excessive assets might load up with debt and repurchase its own shares, move its facilities, invest in diversification or otherwise make its opperations more efficient.

Poison pills are designed to make a takeover less attractive and are subject to a variety of rules to protect shareholders from a self interested management. They also can’t be put in place after a company’s shares have been put into play. Golden parachutes for executives are a simple form of poison pill. Others, like the yahoo deal, are designed to dilute share value but they would have to be a bit more disadvantageous for the company then Dr. Jacksons example. The problem his scenario faces is that his little company now has 10 million in cash. I think it more generally takes the form of an offering to existing shareholders at a lower price. This has the added advantage of forcing shareholders to participate if they don’t want their holdings diluted.

When first conceived they could be pretty nasty, for instance they might only apply to one class of shares to the disadvantage of other shareholders. Laws in response have made it far more difficult to use poison pills that do any more then slow down the purchaser. This is justified as giving management time to find alternate bidders or white knights to pump up the takeover price.

IIRC, the disclosure figure is 5% – that is, when you own (or maybe even control through proxy?) more than 5% of a company’s shares, you must disclose your ownership.

  • Rick

I don’t mean to beat up on the other posters, but I happen to know a little corporate law, and you might want to listen to me.

A poison pill, also known euphamistically as a “shareholder rights plan,” is one particular kind of anti-takeover device (there are many kinds). Adopted by management of companies who fear hostile takeover, poison pills work as follows:

When an hostile acquirer acquires a certain percentage of the target company’s shares, the poison pill is activated, (assuming that management does not de-activate the pill --this feature allows for friendly takeovers). After activation, the shares owned by all shareholders except for the hostile acquirer are multiplied, perhaps doubled. This dilutes the shares held by the acquirer.

So if Hostile Co., Inc. acquires 15% of Yahoo’s shares, and the pill goes into effect, suddenly Hostile Co. has only 7 1/2 % of the shares. The obvious effect is that Hostile Co. will now have to spend more money to reach 50% of the shares, thus discouraging takeover attempts.

But poison pills are more insidious than this. You see, they encourage shareholders of the target company to “hold out” and not tender their shares to the acquirer, since the remaining shareholders get their shares multiplied. As a result, shareholders will be disinclined to tender their shares in response to a hostile bid for a company.

Poison pills have been challenged in court on the theory that they don’t treat shareholders equally. When I studied corporate law, these challenges hadn’t fared too well, as I recall. In any event, many (most?) takeover battles end up in court, and judges decide what is fair and what isn’t.

Hope that helps!