What is the defense of a ‘poison pill’?

On Friday, Twitter offered to buy Elon Musk’s company for more than 43 billion with a corporate tool known as the Toxic Pill, a defensive tactic that seeks to block familiar takeovers near the boardroom but is less familiar to everyday investors.

This defense system was developed in the 1980’s when company leaders, in the face of corporate aggression and hostile acquisitions, sought to protect their business from being taken over by another enterprise, individual or group.

A poison pill is a strategy that usually makes it less expensive for a potential acquirer to make it more expensive for the acquirer to buy shares of the target company above a certain threshold.

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

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

A poison pill is officially known as a shareholder’s right plan, and it may appear in a company’s charter or bye-law or exist as an agreement between shareholders.

There are different types of poison pills, but in general, they allow certain shareholders to buy additional stock at a discounted price, says Ann Lipton, an associate professor of law at the University of Tulane.

Only one shareholder who triggers poison pills has been barred from making these discounted purchases. This is triggered when a person, usually the acquirer, hits a threshold for the ownership of his shares. If they reach that threshold, their share price plummets as other shareholders buy at a discount.

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

Pizza chain Papa Johns received a poison pill in July 2018. In a rare instance, a company tried to prevent its founder from taking responsibility. After using a racial slogan in a conference call and making a fuss, founder John Snatar resigned as chairman of the company’s board that year, owning 30 percent of the stock at the time.

Poison Pill would allow shareholders to buy stock at a discount if Mr. Snoter, his family members 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, if Mr. Musk, or any other individual or group working together, buys 15 percent or more of Twitter’s shares, the pill will flood the market with new shares. This would immediately dilute Mr Musk’s partnership and make it significantly more difficult to buy a large stake in the company. Mr Musk currently owns more than 9 percent of the company.

Mrs Lipton said a company could be limited by the ceiling in its charter on how many shares it is allowed to use. But even if it hits that ceiling, he said a company has other options to make the purchase attractive.

And toxic pills can also be avoided if the acquirer or shareholder sues the company for breach of its fiduciary duty. But Ms Lipton said the court had shown “incredible reluctance” to intervene.

“Boards have a great deal of leeway to judge what is in the best interests of shareholders, especially if they are formed by independent directors,” he said. Boards often apply poison pills on a temporary basis so they can take more time to consider their options.

Very, according to Professor Chatman. He said hostile takeovers were not as common in the 1980s because potential acquirers now speculate that companies have provisions for poison pills.

Netflix successfully thwarted billionaire investor Carl Icon in November 2012 by using a poison pill that made it more expensive for Mr. Icon or any other individual or group to acquire more shares of Netflix if they acquired a 10 percent stake in the company. Without the approval of its board.

About a year later, in October 2013, Jose Warehouse received a poison pill. A. The bank survived an acquisition attempt by Clothiers. (Men’s Warehouse then acquired Jos. A. Bank in March 2014 and the owner of both companies filed for bankruptcy in August 2020).

In September 1985, in response to rumors that consumer product company Philip Morris had targeted it, McDonald’s Corporation stated that it had adopted a poison pill plan to prevent “abuse tactics.” (The company stated that the plan was not adopted in response to a known proposal.) A few years later, the Walt Disney Company announced that it had adopted an “appropriate and reasonable way to protect the interests of all stockholders.”

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