Last Updated on December 18, 2022 by Anda Malescu
The shareholder rights plan, also known as “poison pill”, is a defensive mechanism used by the board of a company to avoid a hostile takeover by another larger company. The shareholder rights plan was first introduced in the United States in 1982 and since then it has displayed a high rate of success in preventing hostile takeovers.
In a hostile takeover, one company or an individual (referred to as the acquirer) attempts to acquire or merge with another company (referred to as the target company) against the wishes of the target company whose board of directors is unwilling to agree to a merger or acquisition. In other words, a hostile takeover is an attempt to buy the company when those who manage the company do not want to sell it. To prevent or discourage these attempts, the target company’ board uses the shareholder rights plan as a defense tactic to make the company’s shares undesirable to the acquiring firm.
In practice, the shareholder rights plan is a warrant or an option that comes with purchasing the shares (ie. is attached to the existing shares) and gives the existing shareholders of the company the right to purchase additional shares at a discounted price. This in turns dilutes the ownership percentage on any new hostile parties. Further, the shareholder rights plan is usually triggered when whenever a shareholder reached a particular percentage ownership in the company.
To illustrate how the shareholder rights plan works, let us discuss the Netflix case
In 2012, after shareholder Carl Icahn purchased nearly 10% of Netflix stock, Netflix announced it adopted a shareholder rights plan to prevent a hostile takeover. Under the plan, Netflix would issue a right to each existing shareholder to purchase one thousand of a share of a new preferred share series at a price of $350 per right. Further, a Netflix shareholder could exercise the right to buy additional shares at a discounted price only if a person or a group would acquire 10% of Netflix, or 20% in the case of institutional investors, if the deal was not approved by the Netflix board. This way, Netflix would issue more shares and dilute their value, leaving outside investors with an expensive decision to make.
Essentially, the outside investors who would attempt a takeover of Netflix would have to purchase even more shares and the process would become even more expensive than initially projected. After Netflix adopted this shareholder rights plan it received no takeover offer from Icahn or others. This means that the plan prevented Icahn or outside investors from engaging in a hostile takeover.
As seen in our example, the shareholder rights plan has advantages and disadvantages.
The main advantage is that it is effective at discouraging and preventing hostile takeovers. Companies that can easily be acquired by a larger company can use these rights to continue in the marketplace. Further, the board of the target company has time to find an acquiring company that offers a better price and more favorable terms.
However, the disadvantage is that existing shareholders have to purchase new shares to keep their percentage ownership.
The shareholder rights plans are controversial and require the right financial adviser and attorney to advocate for your company’s best interest. Contact us or schedule a consultation with our business lawyers in Miami, Florida USA to help you with the shareholder rights plan.
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