Lately, everyone is talking about how Elon Musk acquired Twitter after the Twitter board initially adopted a poison pill but eventually decided to sell anyway. So what is a poison pill, and how does it work to prevent a hostile takeover? What is a hostile takeover anyway? Are there other ways for a company to protect itself from a hostile takeover? Let’s do a deep dive here.
A hostile takeover is when an acquirer of a company wants to do so against the company’s management and board’s will. For example, the infamous failed Microsoft-Yahoo Acquisition was an attempt at a hostile takeover.
The rationale behind a hostile takeover varies. Sometimes the acquirers initiate an acquisition believing that the acquisition or merger of two companies can create strategic value; however, the attempt was not accepted by the target companies’ board or management for various reasons. The Microsoft-Yahoo Acquisition mentioned above is a good example of an attempted strategic deal. Similar examples include the attempted Broadcom/Qualcomm deal, which was eventually blocked due to national security concerns.
In other instances, the drivers of hostile takeovers are so-called “Corporate Raiders” or “Activist Shareholders,” such as the infamous Carl Icahn. They tend to find companies that they believe to be “undervalued” and then, by controlling the company, force the companies to replace their management, downsize their operations, or even liquidate. Their goal is to profit from such transactions eventually, often disregarding the minority shareholders’ rights.
Companies typically have two main types of stock: common shares and preferred shares. Preferred shares are typically reserved for investors with certain preferential treatments such as liquidation preference and participating rights. They usually don’t carry voting rights. However, they do have other advantages, such as higher dividends.
For common shares, there can be different classes of common shares, some of which can carry “super-voting rights.” The super-voting rights are a great mechanism for founders or other insiders to be able to vote on certain issues with a limited number of shares yet exercise far more power and control. For example, Google has three classes of shares: Class A, ticker name Googl, one vote per share; Class B, not publicly traded but only granted to insiders, ten votes per share; and Class C: ticker name Goog, no voting rights. Establishing such a structure is a great preemptive measure against hostile takeover attempts.
In many cases where founders were ousted, it would have been much more difficult for the board to out the founders if they had such a structure. For example, the notorious WeWork's previous CEO, Adam Neumann, negotiated such rights for himself. That was a heatedly debated practice, and the SEC publicly condemned it, calling it a “Recipe for disaster.” However, as founders, if you don’t want to deal with what happened to Steve Jobs or Tim Kentley-Klay, this is worth considering while setting up your company's share structure.
In the recent Twitter saga, the Twitter board adopted a poison pill right after Elon’s takeover attempt.
A “Poison Pill,” also known as a Shareholder’s Right Plan, was invented by Martin Lipton, co-founder of the top-ranked wall street law firm Wachtell, Lipton, Rosen & Katz. There are two types of poison pills: flip-in and flip-over. The flip-in allows company shareholders to buy new stock at a discount if the acquirer gathers a certain percentage of shares of the company. The acquirer is excluded from such purchase, so its ownership interest is diluted. The flip-over allows the target company’s shareholders to purchase the acquirer’s stock at a deeply discounted price if the takeover goes through, which punishes the acquirer by diluting its equity.
On the other hand, a poison pill cannot prevent a tender offer, an additional way that a hostile takeover can happen. Basically, the acquirer can offer to buy the company’s shares for a premium well above the market price, enticing the shareholders to “tender” their shares. Once achieving majority shareholding this way, the acquirer can then force the board or the management team to carry through with the acquisition. For an acquirer, a tender offer can be expensive and time-consuming. There are also very stringent legal requirements regarding a tender offer. The Xerox HP acquisition eventually turned into a tender offer battle that failed in the midst of the Covid-19 impact. In Elon’s case, it was unclear whether an attempted tender offer would be successful in achieving his goal of acquiring Twitter. Luckily for Elon, the board eventually accepted his offer and disarmed the poison pill, and the acquisition was successful.
In the case of Twitter, if it didn’t want to be acquired by Elon Musk, who allegedly didn’t really have a strategic or technical reason to acquire it (after all, Elon’s forte is in rockets and cars), it could have gone out to find another strategic acquirer who would be willing to acquire them in a friendly, cooperative way. For example, given the space Twitter plays in, being acquired by Facebook may have been a much more strategic alliance and created economies of scale and synergy. If this were to be the case as Facebook did in the past pursued Twitter, Facebook would have been the White Knight, as opposed to Elon Musk being the “Black Knight.”
Of course, there are a number of other ways a company can resist tender offers, as detailed by Biryuk law here. It includes a technique that has the management buy out the company themselves, referred to as a “Leveraged Buyout.” It also includes other techniques such as forcing the company to take on more debt and making it a less attractive acquisition target, giving management and key employees a way to leave the company to decrease a company’s value by offering them a “Golden Parachute,” forcing the company to sell its most valuable assets, i.e. a “Crown Jewel,” if a hostile takeover were to happen, etc. The one I found the funniest is called a “Pac-Man.” Basically, the target will try to take over the controlling interest of the hostile potential acquirer. Good luck trying that on Tesla, Twitter.
While folks at Techcrunch seem to think hostile takeovers are “doomed,” Delaware courts ruled against the board of directors for failing to sell the company to the highest bidder, thus the famous Revlon Rule. Other popular success stories include InBev’s acquisition of Anheuser-Busch, Sanofi-Aventis’s acquisition of Genzyme Corporation, etc.
There is great literature out there about how potential targets can preemptively monitor and fend off hostile takeover bids, such as this Harvard Law Review article here, as well as this other piece on Guidepost. Even though the Twitter/Elon Musk story somewhat had a happy ending, founders and executives should start with a solid foundation such as multi-tier stock, proxy rights, and a tiered board. In addition, they should always evaluate the strategic playground to identify potential enemies and plan ahead to form alliances with friendly players.
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