What Is a Target Firm?

A target firm or target company refers to a company chosen as an attractive merger or acquisition option by a potential acquirer. A takeover attempt can take on many different flavors, depending on the attitude of the target firm toward the acquirer. If management and shareholders favor the transaction, then a friendly and orderly transaction can ensue. In a merger or acquisition, the target company becomes grafted into the acquiring firm or company.

Beyond outright takeover attempts, as has been the historical norm, shareholder activism is a contemporary twist on the definition of "target firm." For instance, as the importance of gender equality, environmental concerns, and cybersecurity issues grow in popularity—it's common for the media, analysts, and shareholders to 'target' a firm for a variety of shareholder or stakeholder activism efforts.

Key Takeaways

  • A target firm is an attractive company sought for merger or acquisition.
  • Only if the target firm's management, shareholders, and board of directors agree with the takeover can the transaction occur smoothly.
  • If not in agreement, the target firm can use special tactics to try to stop a hostile takeover, such as the crown jewel or poison pill strategy.
  • Target firms are usually acquired at a premium, a value exceeding its current fair market value.

Understanding Target Firms

Target firms are often acquired at a price that is somewhat more than their fair market value. This has come to be widely known as a takeover premium. This is rational when the acquiring firm perceives an additional strategic value to the acquisition, such as greater economies of scale.

These economies do not always materialize since there can be additional hidden costs associated with the integration of two firms, particularly for business operations with deeper cultural or social differences than previously recognized.

In the case of mergers and acquisitions (M&A), friendly takeover attempts are far more common, though hostile takeover attempts tend to dominate the news. In reality, hostile takeover attempts of the Hollywood variety are far more costly and time-consuming than potential acquirers would prefer.

Sometimes, the identity of the target firm may remain as part of the new entity. This is common when the target firm has a good reputation and/or a good customer or supplier base and vacating the name would cause irreparable harm. When management and shareholders oppose the transaction, the target firm may attempt a variety of hostile actions to thwart the takeover attempt.

In financial jargon, a target firm has traditionally been considered a "target" for acquisition; more contemporary definitions also lump target firms with shareholder activism campaigns. Shareholder activism is a modern approach to driving change without the messy hassle of expensive takeover attempts. As such, it's not uncommon to hear a company or industry described as a "target" of ESG led shareholder engagement initiatives.

Target Firm Resistance Tactics

Sometimes, the target firm's management or board of directors are against the merger or acquisition. They may use different tactics, such as the poison pill or crown jewel defense, to stop the takeover.

Under the poison pill strategy, the target firm employs a shareholder rights plan whereby the company extends options or warrants to existing shareholders to purchase additional shares at a discount. If successful, the acquirer's ownership interest is diluted, making the target firm less attractive. The poison pill strategy may be used to stop a takeover or to transfer bargaining power to the target firm.

The crown jewel defense refers to when a target firm sells its most valuable assets, known as the crown jewels, to a third-party, known as the white knight. If successful, the acquirer is no longer interested in acquiring the company and withdraws its bid. To restore itself to a better position, the target firm can then repurchase the assets from the white knight at a specific price.