The Poison Pill Defense

Does a Shareholder Rights Plan Always Benefit the Shareholder?

(Originally appeared in the May 18th, 2022 'Across the Board' digital publication, a Board Director, Board Advisor, C-Level, and Business Leader publication reaching 27,500+ exceptional business leaders in over 70 countries with articles focused on leadership, strategy, and governance topics - sign up here)

With all of the recent news regarding a potential Twitter takeover by Elon Musk, it seemed an opportune time to dig into a protective mechanism some Boards have felt the need to deploy - a poison pill strategy. Although the number of implemented poison pill events has consistently dropped over the past 15 years, when enacted it is commonly quite a colorful experience. Additionally, and seemingly tangential, it can be an important topic as it relates to a Board's duty of care and duty of loyalty in support of the business judgement rule (more on this later...).

Poison Pill: a defense strategy used by a target firm to prevent or discourage a potential hostile takeover by an acquiring company. Potential targets (companies) use this tactic in order to make the organization look less attractive to the potential acquirer.

As the name signifies, a poison pill should indeed sound like something that is difficult to swallow, as this is its metaphorical meaning. Poison pills are typically designed to protect shareholders from a change of control transaction lacking what the targeted company would view as an "appropriate control premium." Companies being targeted for an unwanted takeover have the option to enact a poison pill strategy to make their shares unfavorable to the acquiring firm or individual. By design, poison pills in many cases raise the cost of acquisitions significantly, creating disincentives in an effort to deter hostile takeover attempts. By doing so, a company can protect minority shareholders and avoid change of control in company management, hence the other name for a poison pill strategy - a shareholder rights plan.

Although implementing a poison pill strategy is not always the best nor only way to defend a company from a hostile takeover, it is generally very effective and can be the path of least resistance for a Board of Directors to enact on behalf of the company. However, can a poison pill strategy implemented by a Board of Directors not always be in the best interest of all shareholders, including minority shareholders? Absolutely.

As a Director, it is important to first understand two types of poison pill strategies:

• Flip-in Poison Pill: A flip-in poison pill strategy involves allowing shareholders (and not the potential acquirer) to purchase additional shares at a discount. The purchasing of additional shares provides shareholders with instantaneous profits while simultaneously, and purposefully, diluting the value of the limited number of shares already purchased by the acquiring company. This right to purchase discounted shares is given to the shareholders before a takeover is finalized and is often triggered when the acquirer amasses a certain threshold percentage of shares of the target company. (Note: this is the poison pill option Twitter initially planned to enact)
• Flip-Over Poison Pill: A flip-over poison pill strategy allows shareholders of the target company to purchase the shares of the acquiring company at a deeply discounted price if and once a hostile takeover attempt is successful. In this poison pill strategy, a target company shareholder gains the right to buy the stock of its acquirer at a discounted rate (i.e. two-for-one, three-for-one, etc.), thereby diluting the equity in the acquiring company. This approach is designed to disincentivize the acquirer and force the abandonment of the acquisition attempt due to post-acquisition dilution.

In the case of Twitter, Elon Musk's offer to acquire the company was at a premium - Musk made an offer to buy Twitter for $54.20 per share on April 14th, 2022. At the time of his offer, this was a 54% premium over the day before Musk began investing in Twitter and a 38% premium over the day before his investment was publicly announced (in a recent development, Musk hinted that he would like to pay less than his $44 billion offer if the estimated 5% of fake Twitter accounts is actually much higher).

This being said, is a Board truly "looking out for" its shareholders, including its minority shareholders, by scuttling a hostile takeover that has the ability to earn significant profits for all investors? How does the Board weigh the pros and cons of protecting against or supporting a takeover? What premium over current share value is acceptable? Does the company's near-term earnings potential and believed future stock elevation outweigh the immediate tendered takeover offer? Is protecting a company’s unique corporate culture from change a valid stance?

For a Board, implementing a poison pill strategy does not always indicate that the company is unwilling to be acquired. In many scenarios, it is enacted to gain additional decisioning time and to force a higher valuation leading to more favorable acquisition terms for the company.

There can be, however, a few disadvantages to poison pills:

• Stock values can become diluted, so shareholders are often forced to purchase additional shares to remain at their prior investment level.
• Institutional investors can be discouraged from buying into corporations that have aggressive defenses.
• Ineffective managers, leaders, and Board Directors can remain in place at the detriment of the company.

These downsides beg the question mentioned in the subtitle of this article: "Does a shareholder rights plan always benefit the shareholder?" And, has the Board truly lived up to its duty of care and duty of loyalty when implementing a poison pill? It will never be an easy decision for a Board to decide whether or not to acquiesce to a takeover plus lose their control, but it is indeed an important decision - one that may have increasing legal implications if company control is prioritized over shareholder payout value.

There is some related legal precedent in this area for those readers interested in learning more. See the following cases:

• Yucaipa v. Riggio
• eBay v. Newmark (Craigslist)
• Versata v. Selectica

It is worth mentioning a curious nuance in the world of poison pills. Fact: the effectiveness of a poison pill strategy is elevated when the target company has a staggered or classified Board (when Directors are placed on 2 or 3 term "classes" with only one class of Directors coming up for reelection in that year). This is quite interesting as the use of staggered Boards has greatly diminished over the past decade in favor of yearly elections for all Directors. In cases where staggered Boards are in place, and when an acquirer is unsuccessful in convincing the Board of accepting its takeover bid, it becomes more difficult for the acquirer to force its will. In these scenarios, even when the acquirer has directly appealed to the shareholders, the ability to expeditiously replace a majority of the current staggered Board with those more receptive to the acquirer’s bid becomes exponentially more challenging. In essence, the acquirer would need to prevail in two consecutive annual proxy contests to gain a majority of the Board - a daunting undertaking.

Boards should prepare themselves for effective and strategic response steps to hostile takeover actions, even if they believe none loom on the immediate horizon. Scenario Planning is a great way to accomplish this and should include detailed internal and external communications plans. If your company does become an acquisition target, be prepared - the public optics of the company and the Board will increase immediately.

Is your Board versed in hostile takeover considerations?

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Mark A. Pfister - Non-Executive Director | CEO | Chief Board Consultant | Corporate Strategist | Board Macro-Influencer | Speaker | Author - www.PfisterStrategy.com

About the Author: With a strong focus in Strategy, Governance, and Technology/Cybersecurity, Mark A. Pfister is CEO & Chief Board Consultant of M. A. Pfister Strategy Group, an executive advisory firm that serves as a strategic advisory council for executives and Boards in the public, private, and nonprofit sectors. He is also Chairman & CEO of Integral Board Group, a specialized Board services and consulting company. Mr. Pfister is a 'Board Macro-Influencer' and his success has been repeated across a wide range of business situations and environments. He prides himself on being a coach and mentor to senior executives and directors. In Board Director circles, Mr. Pfister has earned the nickname 'The Board Architect’............. << read full bio here >>

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