DEFINITION: A “poison pill” is one of several defensive tactics for resisting a hostile corporate takeover that are available to the management of the target company.
ETYMOLOGY: The phrase “poison pill” is a colloquial way of referring to what is technically known as a “shareholder rights plan.”
USAGE: A hostile takeover situation arises when one company’s bid to take over another one is substantially higher than the market price and yet is rejected by the target company’s management team.
Traditionally, the principal means by which a bidding company attempts to take over a company against the wishes of its management is by going over the heads of management and negotiating directly with shareholders to acquire a voting majority of shares.
The concept of the shareholder rights plan, or poison pill, was invented by the mergers and acquisitions attorney Martin Lipton in 1982.
In a nutshell, what Lipton did was to devise language to be added to a company’s bylaws which states that in the event an outside bidder purchases a given percentage of shares (typically, 20%), the existing shareholders would be offered additional shares for purchase at a discount.
The idea was that the shares purchased by the bidding company would be diluted in such a way that it would be unable to accumulate a controlling interest in the target company.
The colloquial name by which such shareholder rights plans became known derived from the fact that a hostile bidder typically lacks access to the target company’s bylaws. Thus, it would have no way of knowing in advance that its effort to buy up shares in the target company would trigger the discount for existing shareholders.
In this way, the bidding company would, in effect, have swallowed a pill that ended up poisoning the purchase it hoped to make.
There are numerous refinements to the concept of the shareholder rights plan—various flavors of poison pill, if you will—including “preferred stock plans,” “flip-ins,” “flip-overs,” “back-end rights plans,” and “voting rights plans,” which are variations on the theme just outlined.
The poison pill tactic was used extensively during the 1980s and 1990s by such famous “corporate raiders” as T. Boone Pickens and Carl Icahn.
Quite recently (spring of 2022), the concept of the poison pill has been back in the news in connection with Elon Musk‘s much-discussed hostile takeover bid against Twitter.
However, in recent years shareholders have increasingly balked at incorporating poison pills into their company’s bylaws, mainly because they have an economic interest in seeing their company sold at an above-market price—thus inflating the value of their shares—even against the wishes of management.