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What is a Lobster Trap?
What’s important to know about it?
In this article, I will break down the meaning of Lobster Trap in Business so you know all there is to know about it!
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What Is Lobster Trap
A lobster trap refers to a defense mechanism used by companies that are the target of a hostile takeover attempt.
The idea behind the lobster trap defense is that the target company prevents any shareholder having more than 10% of the company’s shares to convert any other securities into voting shares.
The objective is to ensure that shareholders with a large interest in the company are unable to convert securities such as bonds, convertible preferred shares, warrants, or convertible debentures into voting shares.
The term “lobster trap” comes from the fact that real-life lobster traps are designed to catch large lobsters and let the small ones escape.
For this type of defense strategy to be used, the target company must adopt the lobster trap defense mechanism in its charter.
When there’s a hostile takeover attempt, the acquiring company (the black knight) has an immediate interest in wanting to control as many voting shares as possible in the target company.
When there’s a sufficient level of voting shares that are controlled by the black knight, it can effectively acquire a controlling interest in the target firm.
The lobster trap is one technique among other defense strategies to fend off hostile takeover attempts.
Keep reading as I will break down the lobster trap in mergers and acquisitions further.
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Why Use A Lobster Trap Defense
The are many benefits to using a lobster trap defense in hostile takeover situations.
The most important benefit of using a lobster trap defense is to prevent large shareholders from exchanging their convertible securities for voting stock.
In some cases, an acquirer will not directly state its intention of acquiring another firm and will slowly start buying voting shares of the target over time.
When a shareholder acquires more than 10% of a company’s voting shares, that shareholder will start having more influence in the company.
If the shareholder’s objective is to acquire a controlling interest in the target firm, the lobster defense will make it harder to achieve the 51% mark.
Another reason why companies use a lobster defense strategy is to force the acquirer to purchase more voting stocks directly without converting convertible securities.
When a company has many convertible securities that can be exchanged into voting stocks, the lobster strategy will be more effective.
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How The Lobster Trap Defense Works
In corporate finance, the lobster trap refers to a specific type of defense strategy used by target companies to defend themselves against hostile takeover attempts.
A hostile takeover is when a company attempts to acquire a controlling interest in another without the express consent of the target firm’s board of directors.
In other words, the acquiring company’s objective is to either buy as many voting shares of the target company or make an unsolicited offer to the target firm’s shareholders so they sell their shares.
One specific defense strategy that can be used in situations where an acquiring company has purchased a substantial percentage of voting shares (10% or more) is the lobster trap.
The lobster trap defense requires that the target company have the lobster trap protective provisions in its charter allowing it to use such a defense.
When a black knight has acquired 10% or more of the voting shares of the target company, the lobster trap provision will be triggered preventing the black knight from converting convertible securities into voting stocks of the company.
This is highly useful in situations when a target company has many convertible securities like bonds, debentures, preferred shares, and warrants in the market.
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Hostile Takeover Defenses
There are different types of hostile takeover defenses that target companies can use to defend themselves against unsolicited offers.
The lobster defense is one strategy among many strategies that companies can use to fend off a hostile acquisition.
Here are the most common types of hostile takeover defense strategies:
- Stock repurchase
- Poison pill
- Staggered board
- Shark repellants
- Golden parachutes
- Standstill agreement
- Leveraged recapitalization
- Leveraged buyout
- Crown jewels
- Scorched earth
- Pacman defense
- White knight defense
- White squire defense
- Change of control provisions
- Lobster trap
As you can see, there are many ways a company can defend itself against a hostile takeover.
Keep in mind that the lobster trap defense can be used along with other defense strategies, such as having a staggered board, poison pill, or white knight.
Recommended article: What is a black knight in M&A
Lobster Trap Example
Let’s look at an example of a lobster trap defense to see how it works.
Let’s assume that Company ABC is the target of a hostile takeover attempt by Company XYZ.
Company XYZ needs to purchase 51% of Company ABC’s voting shares to acquire a controlling interest.
Company XYZ’s plan is to acquire 40% of the company’s common shares and acquire Company ABC’s convertible securities to convert for another 11% of common shares.
The strategy is to directly purchase 40% common shares and acquire another 11% voting rights by converting preferred shares and convertible debentures of Company ABC into common shares.
If Company ABC does not have a lobster trap defense in its charter, this strategy can work for the acquirer.
However, if Company ABC has adopted a lobster trap defense provision in its charter, Company XYZ will not be authorized to convert its preferred shares and convertible debentures into common shares.
This will make the acquisition somewhat harder for Company XYZ.
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So there you have it folks!
What is a lobster trap defense?
In a nutshell, a lobster trap defense in M&A refers to a strategy that a target company uses to defend itself against an unwanted hostile takeover bid.
The lobster defense is a strategy where a company adopts certain provisions in its charter preventing shareholders with more than 10% voting shares from exchanging convertible securities for more voting shares.
For instance, holders of warrants, convertible preferred stock, convertible bonds, and convertible debentures will not be able to convert such securities into voting shares.
Smaller companies tend to use the lobster trap defense as a means to protect themselves against hostile takeover attempts by much larger organizations.
Now that you know what a lobster trap is in business and how it works, good luck with your research!
I hope you enjoyed this article on Lobster Trap! Be sure to check out more articles on my blog. Enjoy!
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