What is the poison pill? The term poison pill refers to a shareholder rights plan that prevents activist investors and raiders from acquiring shares. Poison pills effectively stop shareholders from accumulating shares above a set amount. This plan is put in place by companies in order to keep outsider parties from gaining control of public companies without negotiating. Poison pills have been deemed effective by courts as a way for corporate boards to defend their integrity.
Specifically, the poison pill sets a quota for shares that no shareholder is supposed to exceed. If shareholders exceed this limit, corporate boards will distribute free or heavily discounted shares to other shareholders. It is important when using poison pills, for companies to be able to show they are responding proportionally to a credible threat.
Takeovers are common in the corporate world when a company shares are completely transferred to a different company or private equity firm. Luckily, companies have many defenses, such as the poison pill. It is common for a poison pill to demand that if one shareholder acquires more than 15%, then all other shareholders are given access to shares at half price. This helps to dissuade shareholders from exceeding their limit of shares and lessens the discrepancy between shareholders. These were the terms that Twitter agreed to in April 2022.
The poison pill was devised in the 1980s, in New York, by a couple of large public companies, in order to combat a wave of activist investors taking over companies. The poison pill does not always mean that the company does not wish to be acquired. In fact in Twitter’s case, they enacted a poison pill in order to raise the value and were soon after bought by Elon Musk.
Poison pills have many advantages. They prevent majority takeover by minority interests and instead keep power with the majority while honoring everyone’s interests. They also, recently, have been preventing takeovers set in motion by the decline in market prices caused by post Covid-19 economics. By using poison pills, companies are also able to raise their market value and can be acquired at a high price, if they wish.
Though the advantages outweigh the disadvantages of poison pills, market prices do go down in the short term while using a poison pill. They are also capable of shielding underperforming companies from a takeover which can hurt the company in the end.
However, poison pills are an effective mechanism of defense against unwanted takeovers and activist investors.