What is a Toehold Purchase

A toehold purchase is accumulation of less than 5% of a target company's outstanding stock by another company or investor with a particular goal in mind. If the toehold purchase is made by another company, it may be a precursor to a takeover bid or tender offer. If a large investor is making the toehold purchase, it usually is accompanied by demands that the target company take a number of steps to increase shareholder value of the firm.

BREAKING DOWN Toehold Purchase

A toehold purchase by a company may be a signal that it is interested in eventually acquiring the company. This potential acquirer can quietly amass up to 5% for its toehold as it considers its strategic options. But if it crosses the 5% threshold, it must file a Schedule 13D with the SEC and explain to the target firm in writing the reason for the purchase of 5% or more of its stock. Filing a Schedule 13D additionally notifies the public of what the company is intending to do with its toehold purchase.

A toehold purchase by an investor normally means that it intends to shake up the target firm in certain ways in an attempt to boost the market value. This activist investor would announce to the Board of Directors of a company in a public letter that it has built up a material stake, outline its reasons for its investment, and suggest (or demand) specific actions to increase shareholder value. This notification to the public can, and often does, take place before the 5% mark is reached.

Activist's Toehold Success Example

A prominent activist investor, Paul Singer of Elliott Capital Management, has had much success with the strategy of making toehold purchases, agitating for changes at his targeted investment, and then eventually cashing out at substantial profits if his recommendations or demands are implemented effectively. In November 2016, Singer disclosed a 4% holding in Cognizant Technology Solutions along with his ideas for lifting profitability and returning cash to shareholders. He also insisted on change at the Board level. The results were swift — in February 2017, Cognizant agreed to replacing three new independent directors and committed to plans to expand profit margins and return capital to shareholders.