DEFINITION of 'Lobster Trap'

A lobster trap is a strategy used by a target firm to prevent a hostile takeover. A lobster trap anti-takeover strategy involves the target company passing a provision that prevents any shareholder, with an ownership stake of over 10%, from converting securities into voting stock. This prevents large shareholders from adding to their voting stock position and facilitating the takeover of the target company. “Lobster Trap," yet another colorful entry in the lexicon of anti-takeover terminology, is derived from the fact that such traps are aimed at catching large lobsters but not small ones.

BREAKING DOWN 'Lobster Trap'

The convertible securities covered by the “lobster trap” provision include any securities that can be converted into voting stock — convertible bonds, convertible preferred shares, convertible debentures and warrants.

The lobster trap is just one tactic in an arsenal of defense mechanisms that a company can use to fend off an unwelcome suitor. It can be used either by itself or in conjunction with other tactics such as poison pill, white knight, scorched-earth, crown jewel, etc. to rebuff a hostile acquirer.

Example of a Lobster Trap Strategy

For example, an enterprise named Small Pond Co. may have received a hostile takeover offer from larger rival Big Fish Inc. Small Pond’s directors and management are extremely averse to the company being swallowed up by Big Fish and are trying to drum up shareholder support to reject the offer. They are aware of a large hedge fund that owns 15% of Small Pond’s voting shares, plus warrants that if converted would give it an additional 5% stake in the company. Fortunately, Small Pond’s founders had the foresight to include a “Lobster Trap” provision in their corporate charter to prevent the company from falling into undesirable hands. The company’s Board of Directors, therefore, uses the provision to prevent the hedge fund from converting its warrants into voting shares and succeeds in rejecting the hostile bid.

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