What Is a Poison Put?
A poison put is a takeover defense strategy in which the target company issues a bond that investors can redeem before its maturity date. A poison put is a type of poison pill provision designed to increase the cost a company will incur to acquire a target company.
Key Takeaways
- A poison put is a type of takeover defense strategy designed to make it more expensive for an acquiring company to gain control of a target company during a hostile takeover bid.
- The poison put strategy requires executives of the target company to issue a bond with a poison put covenant.
- The poison put covenant stipulates that bondholders can redeem their bond before the maturity date and receive full payment if there is a takeover of the company.
- The poison put is an added expense the acquiring company must pay if it wishes to acquire the target company.
- In contrast to poison pills, poison puts do not affect shares or voting rights.
How a Poison Put Works
Executives can employ a number of different strategies when defending their company from a hostile takeover bid. Poison pills are one such strategy and are designed to make the prospect of acquiring a company through a takeover bid expensive and less likely to occur. This type of takeover defense is legal, though company executives still have a duty to act in the best interest of shareholders.
Poison puts are a type of poison pill defense in which bondholders are provided with the option of obtaining repayment in the event that a hostile takeover occurs before the bond’s maturity date. The right of early repayment is written in the bond’s covenant, with the takeover representing the trigger event.
Benefits of a Poison Put
During a hostile takeover, an acquiring entity—usually a rival company or an activist investor—attempts to take control of a publicly traded company without the approval of the company’s board of directors. The board has certain strategies at their disposal they can enact to thwart the would-be acquirer.
The poison put can be an effective strategy for the target company because it means the acquirer will have to spend more money to take control of the company. Thus, companies looking to complete a hostile takeover must balance the cost of acquiring a controlling interest in the target company with other acquisition costs.
If a company does not have substantial assets or has significant debt, a poison put could cause financial hardships.
A poison put is different than other poison pill defenses in that it does not affect the number of shares in the market, the price of shares, or the voting rights afforded to shareholders. It instead directly impacts the amount of cash that an acquired company has on hand by shifting bond obligations from the future to the date at which the hostile takeover occurs. The acquiring company must be sure that it has sufficient cash to cover the immediate repayment of bonds.
A poison put strategy may not work for a target company that already has significant amounts of debt, as this strategy increases the company’s debt load and could lead to insolvency.
Alternatives to a Poison Put
Poison put is not the only tactic companies use to disrupt or prevent hostile takeovers. Several other mechanisms have proven successful at thwarting these undesirable acquisitions.
Crown Jewel
A company executes the crown jewel defense when it sells off its most valuable assets, also known as the crown jewels, to make it appear less attractive to the acquiring company. The crown jewels of a company are the revenue-driving assets.
To enact the crown jewel defense, the target company sells its assets to a white knight—a third party that acquires a company under more favorable terms than the hostile black knight. Under this technique, the white knight typically agrees to sell the assets back to the target company after the hostile takeover is terminated.
Stock Acceleration
Much like the poison put option, stock acceleration, also known as triggered-option vesting, is a technique used to ward off hostile bidders by making the company less attractive and more expensive to acquire. Under this strategy, employees’ unvested stock options vest fully and, subsequently, must be paid by the acquiring company when a specific event occurs.
The acquisition is the event that precipitates the accelerated vesting. Therefore, if the sale does not occur, the vesting schedules remain as is. If the acquisition completes, the company may encounter difficulty retaining talented employees whose continued employment may have been largely based on their percentage of vesting.
Pac-Man Defense
Target companies employ the Pac-Man defense to reverse the takeover; under this strategy, the target company seeks to take over the hostile bidder. The acquiree becomes the hostile bidder by obtaining a controlling number of the acquirer’s shares. This not only threatens the acquisition but also the acquirer’s company.
Like its arcade game namesake, the Pac-Man strategy gives the target company, through the use of power, the ability to hunt and consume those who initially targeted them for consumption. To be effective, the target company must have enough power, or resources, to take over the hostile company.
Example of a Poison Put
A company’s board of directors believes that a larger competitor may attempt to acquire it in the future. As a defense, the company incurs new debt by issuing corporate bonds. As part of the newly issued bond, the board includes a poison put covenant, which is a provision that stipulates bondholders can receive early repayment of the debt should a triggering event occur, such as a hostile takeover.
The total value of the bonds is $50 million. For the competitor to successfully acquire the company, it must not only be able to afford the purchase of a controlling interest of shares but also afford a potential immediate repayment of $50 million to bondholders. If the acquirer does not have the money to pay this additional acquisition cost, they may need to withdraw their hostile takeover attempt, which means the poison put strategy was effective for the target company.
What Is a Flip-Over Plan?
A flip-over plan is a strategy in which target company shareholders are able to purchase shares of the acquirer at a discount if the acquisition is fulfilled. These additional shares in the market dilute the existing shareholders’ value.
What Is a Flip-In Poison Pill?
A flip-in poison pill is a strategy that allows all but the acquiring company’s shareholders to purchase additional shares in the target company at a discount. The new influx of shares dilutes the value of shares purchased by the acquirer, thus making the acquisition less attractive and more expensive.
Are Poison Pills Good for Shareholders?
Poison pills introduce more shares into the market, diluting existing shares. Existing shareholders’ ownership is reduced, requiring the purchase of additional shares to return to their previous level of ownership.
What Is a White Knight Strategy?
The white knight strategy involves a friendly third party acquiring the target company under more favorable conditions than those of the hostile bidder or black knight. Often, management and the board of directors remain intact and investors receive more for their money.