Poison Pill (What It Is And How It Works: All You Need To Know)

What is a Poison Pill?

What is a poison pill defense in business?

How does it work?

Keep reading as I have gathered exactly the information that you need!

Let me explain to you what poison pill means once and for all!

Are you ready?

Let’s get started!

What Is A Poison Pill

In business, particularly in the field of mergers and acquisitions, a poison pill is a defensive strategy used by a company (target) to dissuade or prevent another company (acquirer) to pursue a hostile takeover. 

In other words, a company that is the target of acquisition can use a poison pill to make its acquisition less attractive for the acquiring company.

For example, one common poison pill is for the target company to allow its existing shareholders to purchase additional shares at a discount making it more expensive for the acquiring company to pursue the acquisition.

In this fashion, the existing shareholders can not only immediately profit from the deployment of the poison pill but the target company shares will also get diluted.

Keep reading as I will not only define the poison pill but will also provide you details on different types, advantages, disadvantages, and how they are used in practice.

Poison Pill Definition

How do you define poison pill?

According to Investopedia, poison pill is defined as follows:

This definition is quite clear and simple.

In a nutshell, a poison pill is a:

• Defense tactic
• Used by target companies
• To prevent 
• Hostile takeovers

Another definition of poison pill is offered by the Legal Information Institute as follows:

Now, let’s get to the defense strategy, why it’s used, and its main benefits and drawbacks.

How Poison Pill Defense Works

Over the past decades, particularly since the 1980s, companies have more and more adopted defense strategies to prevent or deter other companies from acquiring their shares and becoming majority owners.

In the business world, there are countless acquisitions and for various reasons.

In some cases, a company may acquire another to tap into new markets, to add additional lines of product to their business, for operational benefits, or other reasons.

However, there are instances when the targetted company may not want to be acquired by another.

In that case, a poison pill defense can be an effective strategy to deter the acquirer from pursuing an unwanted takeover.

Typically, the poison pill defense strategies consist of somehow making the targetted company less attractive to be purchased or raising the purchase price making the acquisition cost unfavorable for the acquirer. 

It’s called the “poison pill” as it’s similar to something that is hard to swallow.

The main objective of implementing a corporate poison pill is to protect a company’s minority shareholders and the management in place from an unwanted acquisition.

Poison Pill History

Poison pill in business was first used in the 1980s when there was a surge in mergers and acquisitions in the market.

The law firm Wachtell, Lipton, Rosen, and Kantz first devised the poison pill restriction to defend General American Oil to defend itself against a possible hostile takeover from T. Boone Pickens.

Essentially, Martin Lipton, who invented the poison pill provision, advised General American Oil to issue a large quantity of the company’s common stock to dilute its equity making it more expensive for T. Boone Pickens to pursue its acquisition.

When the poison pill provision was deployed in the 80s, many considered that the company’s board of directors breached their fiduciary duty by diluting the company shares.

However, in 1985, the Delaware Supreme Court ruled that the poison pill M&A defense strategy was legal and could be used by companies to deter hostile takeovers.

Poison Pill Benefits

The main benefit of a poison pill is that it helps deter hostile takeovers.

Even though many acquisitions could result in synergistic outcomes for both the acquirer and target companies, however, it does not apply to all acquisitions.

There are instances that the target company does not see the value of being acquired by another company or that the terms of the acquisitions are not favorable to them.

To ensure that a “hostile” takeover attempt is not made, companies adopt shareholder rights plans to protect themselves against such an eventuality.

Poison pills are also effective in preventing any single shareholder from taking too much control in a company.

In other words, poison pills allow companies to maintain a “democracy” in their shareholder base and ensure that not one single shareholder advances their own agenda to the detriment of the organization.

Poison Pill Drawbacks

One of the main disadvantages of deploying a “poison pill defense” is that the target company’s stock gets heavily diluted.

As a result, the existing shareholders have to accept and cope with the fact that their stock ownership percentage may get diluted.

Unfortunately, most investors do not like seeing their stock position diluted as it means they must invest more money to maintain the same percentage ownership.

Also, in some situations, the shareholder rights plan gets triggered allowing a target company prevents an acquisition that could have actually been beneficial to the company.

In this manner, the implementation of a business poison pill can end up serving the company executives to remain in power rather than result in the best outcome for shareholders.

Types of Poison Pill

What are the different types of poison pill strategies in business?

There are two types of poison pills that companies can adopt: 

• Flip-in poison pill
• Flip-over poison pill

Flip-In Poison Pill

The flip-in poison pill is a defensive strategy that is deployed “before” the hostile takeover is finalized.

Essentially, with a flip-in poison pill, the target company allows the existing shareholders to purchase additional shares at a steep discount when an acquiring company purchases and exceeds a certain threshold of stock ownership.

What’s more is that the acquiring company is typically excluded from the right to purchase additional shares at a discount.

For example, if the acquiring company exceeds a 30% stock ownership in the target company, the poison pill will get triggered and the current shareholders get the right to buy additional shares at a discount.

This dilutes the acquiring company’s stock ownership in the target company and makes the overall acquisition more expensive.

Flip-Over Poison Pill

A flip-over poison pill is a defensive strategy that is adopted “after” the acquiring company completes the hostile takeover.

Essentially, a flip-over poison pill is a type of poison pill allowing the shareholders of the target company to buy additional shares of the acquiring company at a discount.

This strategy ends up diluting the acquiring company’s rights when the target company shareholders end up purchasing voting shares of the acquirer.

This strategy is less common than flip-in poison pills but can also be an effective way for the target company shareholders to gain further control in the acquirer.

Poison Pill Example

Let’s look at an example of how a poison pill may work in practice.

Imagine that Company A (the acquirer) is interested in taking over Company B (the target).

If the acquisition is friendly, Company A will typically need to purchase the majority of Company B’s voting stock to take control of Company B.

If Company B has 1,000,000 shares outstanding worth $10.00 per share, Company A will need to purchase at least 500,001 shares costing it $5,000,010.

However, if Company B has a Shareholder Rights Plan where they have adopted a poison pill, they can make deter Company A from moving forward with the acquisition.

Imagine that Company B has adopted a poison pill where it would allow existing shareholders to purchase shares of the company at a 50% discount if any company buys more than 30% of its common shares.

In that case, if Company A acquires over 30% of the Company B shares, the poison pill will be triggered where every shareholder of Company B, except for Company A, will be entitled to buy additional shares at a 50% discount.

This will not only dilute Company A’s position in Company B but will also result in additional costs for Company A to purchase the necessary 50 + 1 percent of the Company B shares.

Poison Pill Meaning Takeaways 

So there you have it folks!

What is a poison pill in business?

How does a poison pill strategy work?

The poison pill technique, in the field of mergers and acquisitions, is a type of defense strategy companies use against possible hostile takeovers.

The main objective of a poison pill is for the target company subject to a possible hostile takeover to make itself less attractive to the acquirer does not follow through with the acquisition.

Poison pills are effective as it helps protect the target company from abusive acquisitions or acquisitions that do not bring value to the shareholders.

When a poison pill is deployed, it is more likely that the acquirer will engage in a “negotiation” with the target company rather than forcing the acquisition against the target company’s will.

I hope I was able to answer your question related to poison pill business, its history, pros and cons, how it works, and an example of how it may be used by companies.

If you need legal advice relating to hostile takeovers, be sure to consult with an M&A attorney or business lawyer.

Remember, this post is intended to give you general information to get you started in your research and investigation.

Good luck!

My Investing, Business, and Law Blog

By the way, on this blog, I focus on topics related to starting a business, business contracts, and investing, making money geared to beginners, entrepreneurs, business owners, or anyone eager to learn. 

I started this blog out of my passion to share my knowledge with you in the areas of finance, investing, business, and law, topics that I truly love and have spent decades perfecting.

You may find useful nuggets of wisdom to help you in your entrepreneurship journey and as an investor.

I’d love to share the insider knowledge that I’ve acquired over the years helping you achieve your business and financial goals.

Now, let’s look at a summary of our findings.

Understanding The Meaning of Poison Pill

You May Also Like Related to Poison Pill Definition

Related to Business And Acquisition