When confronted with a potentially hostile takeover or bid, a publicly traded company can implement a shareholder rights plan - also called a poison pill - to dissuade the hostile bidder. It dilutes the value of the company and makes the takeover less attractive to the bidder.
How is a Poison Pill Delivered?
A poison pill can take the form of a flip-in or a flip-over. In both scenarios, the company's board of directors votes to initiate the poison pill.
A flip-in occurs when existing shareholders receive the right to purchase shares at a price below market value, according to Investopedia. The bidder does not receive access to this rate.
Flip-overs, by contrast, preempt the takeover by giving shareholders the right to acquire additional shares at a discounted rate only after the merger takes place.
Why are Poison Pills Effective?
Poison pills work because acquiring companies only take over other entities when it benefits them economically. Poison pills reduce the attractiveness of a target company by diluting its value on the open market.
Many companies include poison pill provisions in their by-laws. It's like a "Beware of Dog" sign for a business's front door; it communicates to potential bidders that the company will fight when presented with a potential takeover or merger.
Even though poison pills might only devalue a company in the short-term, it makes the acquisition more difficult for the bidder. Many entities simply drop the issue because they don't want to deal with the headache.
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