Flip-in Poison Pill

What Is a Flip-In Poison Pill?

A flip-in poison pill is a strategy used by a target company to prevent or discourage a hostile takeover attempt. This tactic allows existing shareholders, but not acquiring shareholders, to purchase additional stock in the company targeted for acquisition at a discount.

Flooding the market with new shares dilutes the value of the shares already purchased by the acquiring company, reducing its percentage of ownership and making it harder and more costly for the buyer to gain control. It also enables investors who purchase the new shares to profit instantaneously from the difference between the discounted purchase price and the market price.

Key Takeaways

  • Flip-in poison pill is a strategy enabling shareholders, other than the acquirer, to buy additional stock in a company targeted for takeover at a discount.
  • Flooding the market with new shares dilutes the value of the shares already purchased by the acquiring company, deterring the buyer from crossing the ownership threshold.
  • The provision for a flip-in poison pill takeover defense can be found in the company’s bylaw or charter.
  • The rights to purchase occur only before a potential takeover and when the acquirer surpasses a certain threshold point of obtaining outstanding shares.
  • A flip-over poison pill happens after a hostile takeover is successful and allows shareholders of the target company to purchase shares in the acquiring company at a discount, diluting the shares of the acquiring company's existing shareholders.

How a Flip-in Poison Pill Works

Poison pills constitute a variety of tactics that companies can utilize to keep from being taken over. The tactics make the company less attractive to a potential acquirer and may possibly damage the company—hence, the term "poison pill."

There are a few types of poison pills, such as preferred stock plans, flip-over poison pills, back-end plans, and voting plans. A flip-in poison pill provision is often found in a company's charter or bylaws, a corporate document outlining how the organization is to be run, as a public display of their potential use as a takeover defense. This tells any company thinking about a hostile takeover that they will face difficulties.

The rights to purchase occur only before a potential takeover, and when the acquirer surpasses a certain threshold point of obtaining outstanding shares—typically between 20 to 50%. If the potential acquirer triggers a poison pill by accumulating more than the threshold level of shares, it risks discriminatory dilution in the target company.

The threshold establishes a ceiling on the amount of stock any shareholder can accumulate before being required, for practical purposes, to launch a proxy contest.

Drawbacks of a Flip-in Poison Pill

Companies cannot decide at a whim whether to implement a flip-in poison pill or not. It can only be employed if it is in the company’s bylaws prior to the takeover. When it happens, it can be beneficial in preventing a takeover but can come with many downsides.

Managers that are not good at their job may execute a poison pill to keep their positions. Poison pills can also dilute shareholder power. The stock value may also be diluted. As a poison pill makes a company less attractive, this could turn away potential investors.

Another important thing to bear in mind is that acquirers sometimes try to fight a flip-in poison pill in court. Sometimes they are successful and able to dissolve any program providing the deep discount.

Flip-in Poison Pill vs. Flip-Over Poison Pill

Another defense mechanism used against takeover candidates is a flip-over poison pill. This tactic gives existing shareholders in the company being taken over the right to purchase the acquiring company's stock at a discounted price.

Other defensive strategies to prevent a hostile takeover include white knight, greenmail, an employee stock ownership plan (ESOP), and a staggered board.

This can only happen if the hostile takeover is first successful. This results in the shareholders of the target firm diluting the shares of the shareholders in the acquiring firm. These rights only go into effect when a takeover bid arises and can only be employed if it is included in the bylaws of the acquiring company.

The shares for existing shareholders come with rights that allow them to exercise the purchase of the acquiring company at market price, which is usually double that of the exercise price—the price they receive for new shares.

Example of a Flip-in Poison Pill

Company ABC is a large company in the streaming service space that has seen significant growth in the last five years. Media Mogul DEF is a large media conglomerate that recently purchased a 10% stake in the company. This action set off the alarm bells of Company ABC as it is well known in the financial world that Media Mogul DEF purchases many companies.

To prevent a takeover, Company ABC redrafts its bylaws, stating that if any company purchases more than 10% of the company without approval from the board, Company ABC will release more shares into the market. This would then dilute the current percentage ownership of Media Mogul DEF.

If Media Mogul DEF was still intent on purchasing Company ABC, it would have to spend more money to purchase more shares to gain a controlling stake.

Is a Poison Pill a Good or Bad Strategy for a Company?

A poison pill can be both a good or bad strategy for a company. In general, a poison pill is a very effective defensive tactic in preventing a hostile takeover as it makes the target firm less attractive. A poison pill can make a company's shares unfavorable to an acquiring firm and raise the cost of purchasing the firm. This can be beneficial in keeping a company away, but it can also hurt the company in that it may deter other investors.

Are Poison Pills Good for Shareholders?

Yes, a poison pill can be good for shareholders in that it allows existing shareholders the right to purchase additional shares at a discount. This ends up being worthwhile only if the company's share price remains at or above the discount price the shares were received at.

Are Poison Pills Legal?

Yes, poison pills are legal. They are incorporated into a company's bylaws and have been upheld in court. There are instances where a court can overturn a poison pill tactic; however, they are still a legal form of preventing a hostile takeover.

What Is a White Knight?

A white knight is a defense strategy against a hostile takeover whereby a target company allows for a friendly company or individual to acquire the company to prevent it from being taken over by an unfriendly or hostile company. The white knight comes in and "rescues" the target firm.

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