What is a “poison pill” defense?

On Friday, Twitter countered Elon Musk’s bid to buy the company for more than $43 billion with a corporate vehicle known as the poison pill, a defense strategy familiar to boardrooms to stave off takeovers but to everyday investors is less familiar.

This defense mechanism was developed in the 1980s as corporate leaders faced corporate robbery and hostile takeovers trying to protect their companies from being taken over by another company, person or group.

What is a poison pill?

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

“The key point is to make the board’s offer more attractive than the buyer’s,” said Carliss Chatman, associate professor of law at Washington and Lee University.

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

What does a poison pill actually look like?

A poison pill is officially known as a shareholder rights plan and may appear in a company’s articles of incorporation or articles of incorporation or exist as a contract between shareholders.

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

The only shareholder prevented from making these discounted purchases is the one who triggers the poison pill. It is triggered when an individual, usually the acquirer, reaches a threshold for the number of shares they own. When they hit that threshold, the value of their shares suddenly becomes diluted as other shareholders make discounted purchases.

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

Pizza chain Papa John’s introduced a poison pill in July 2018 in a rare instance in which a company tried to stop its founder from taking over. The founder, John Schnatter, left the company after a report that he used a racial slur on a conference call, a statement he later made in court was mischaracterized. He owned 30 percent of the shares at the time.

The poison pill would have allowed shareholders to buy shares at a discount if Mr. Schnatter, his family members or friends increased their stake in the company to 31 percent, or if someone else bought 15 percent of the shares 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 Mr. Musk or another person or group working together bought 15 percent or more of Twitter’s stock. That would immediately dilute Mr. Musk’s stake and make it significantly more difficult to buy a sizable chunk of the company. Mr. Musk currently owns more than 9 percent of the company’s stock.

Are there limits to using a poison pill?

Ms Lipton said a company can be limited by the cap in its articles of incorporation on how many shares it can issue. But even when it hits that cap, a company has other ways to make buying unappealing.

And poison pills could also be circumvented if the acquirer or shareholders sued the company for breach of its fiduciary duties. But, Ms Lipton said, the courts have shown an “incredible reluctance” to interfere.

“Boards of directors have tremendous leeway to assess what is in the best interests of shareholders, particularly when they are made up of independent directors,” she said. Boards often use poison pills temporarily so they can weigh their options with more time.

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 buyers now assume companies have taken poison pill precautions.

When were poison pills used?

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

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

In September 1985, in the wake of rumors that consumer goods giant Philip Morris was targeting it, McDonald’s Corporation said it had adopted a poison pill plan to prevent “abusive takeover tactics.” (The company said the plan was not accepted in response to a known offer.) A few years later, The Walt Disney Company announced that it had accepted one, calling it “a sound and sensible means of safeguarding the interests of all shareholders.” “.