How do companies use poison pills as a defense against hostile takeovers?

Poison pills are strategies companies use to defend themselves against hostile takeovers. These mechanisms make it more difficult and expensive for an acquiring company to gain control, thereby discouraging unwanted takeover attempts. Here's how poison pills work and why they are used:

1. What is a Poison Pill?

A poison pill is a strategy used by a company to make its stock less attractive or more difficult to acquire. It typically involves issuing new shares or allowing existing shareholders to purchase additional shares at a discount, diluting the value of the acquirer’s shares. This makes it harder for the acquirer to gain control without significantly increasing the cost of the takeover.

2. Types of Poison Pills

There are two common types of poison pills:

• Flip-In Poison Pill: This strategy allows existing shareholders (except the acquirer) to purchase additional shares at a discounted price, which dilutes the acquirer's stake and makes the takeover more expensive.
• Flip-Over Poison Pill: This strategy lets shareholders convert their shares into those of the acquiring company at a discounted rate, which discourages the acquirer by reducing the value of their acquisition.

3. How Poison Pills Protect Companies

The primary purpose of a poison pill is to make a hostile takeover more expensive and less appealing for the acquirer. By triggering a dilution of shares or giving shareholders a chance to purchase stock at a discount, poison pills can prevent or delay an unwanted acquisition. This allows the company’s management more time to find alternatives or negotiate better terms.

In some cases, poison pills might even force the acquirer to negotiate directly with the company’s board of directors, instead of attempting to bypass them through a hostile bid.

4. Legal and Shareholder Impact

Poison pills are often subject to legal review, as they can affect shareholders’ ability to sell their stock or force an acquirer to go through legal channels to gain control. However, shareholders generally approve poison pill strategies because they protect the value of their investments and prevent hostile takeovers that could be detrimental to the company’s long-term prospects.

Despite their effectiveness in staving off hostile bids, poison pills can also have drawbacks. They might discourage friendly acquisitions or cause companies to remain independent when a merger could create value for shareholders.