What is a Poison Pill?

Corporate takeovers are often friendly arrangements, with negotiated terms that both shareholders and management support. However, not every company wants to be taken over — which is when we often start to see the term poison pill making headlines. But what exactly does it mean? Let's take a look.

What is a poison pill?

A poison pill, also known as a shareholder rights plan, is a defensive strategy that companies can implement to protect themselves from being taken over when they don't want to be acquired. Fun fact: The name apparently comes from the poison pill that spies would carry around in case they were captured by their enemies.

In a hostile takeover, a poison pill is an action taken by the target company to make it less appealing to the bidder. Typically, a poison pill allows the company being targeted to flood the market with new shares, thereby diluting the hostile bidder's ownership stake and making a takeover offer by them that much harder to swallow — at times, prohibitively so.

How does a poison pill work?

The most common type of poison pill is known as a "flip-in." This type gives all shareholders of the target company (except for the hostile bidder) the right to purchase additional shares at a discounted rate when a potential acquirer reach a certain ownership level. Typically, poison pills are triggered when a hostile bidder hits that ownership threshold, which often between 10 and 15 per cent but can vary.

A less common poison pill tactic is known as the "flip-over." If a hostile takeover is successful, a flip-over plan would allow shareholders of the target company to buy shares of the acquiring company at a discount. This tactic would dilute the value of the shares of the acquiring company, which could discourage the hostile bidder from following through.

Is it a good idea?

There are many pros and cons for companies to consider when adopting a poison pill. We'll touch on a couple of key ones here.

Perhaps the most obvious upside is a poison pill's potential to block a hostile takeover, maintaining control and management of the company. It can also give management time to seek better offers. On the downside, when new shares are issued at a discount, the value of the stock is affected and investors would be forced to purchase new shares in order to maintain the same stake they held previously. As well, a successful poison pill plan would mean shareholders miss out on a likely hefty premium offered in a hostile bid.

A poison pill is typically used as a last resort by companies that do not want to be acquired. According to the New York Times, the poison pill was developed in the 1980s as a way for company leaders to defend their businesses from being acquired. Hostile takeovers, it says, aren't as common today as they were in the '80s because potential acquirers now assume companies have poison pills in place.