Hostile takeover attempts often take target companies by surprise. In some cases, the potential acquirer may present a highly compelling offer. However, in many cases, the target company will need to implement structural defenses to protect the company from the takeover attempt. Advanced preparation and understanding of key defense mechanisms, such as poison pills, available to companies targeted by a hostile takeover attempt can play a key role in the ultimate outcome.

While a company is under no obligation to accept a takeover proposal or negotiate with a potential acquirer, the directors may have a fiduciary duty to stockholders to adequately consider the proposal. This can especially be the case when the takeover proposal presents a substantial premium to the company’s current stock price. Potential factors that the company’s board of directors should consider in their evaluation of the proposal include the price, potential synergies between the two companies, the deal consideration being offered, and regulatory approval requirements for the merger. Evidence of a proper evaluation process can prevent future shareholder litigation claiming that the company’s board failed to adequately consider the takeover offer.

A key tool to defend against a hostile takeover attempt is implementation of a shareholder rights plan, also known as a poison pill. A shareholder rights plan functions to deter a potential acquirer by diluting their stock ownership. Poison pills can be structured in different ways, depending on the unique circumstances of the hostile takeover bid.

The poison pill is designed to give the company’s existing shareholders, excluding the hostile acquirer, the opportunity to purchase additional shares of the company at a significantly discounted price. This provision of the rights plan is triggered when the hostile acquirer’s ownership exceeds a specified percentage threshold of the target company, typically 10-20% ownership. This is sometimes referred to as “flip-in” rights.

When the hostile takeover involves a tender offer and a proxy fight to replace the target company’s board of directors with a new director slate, a so-called “dead-hand pill” may be implemented by the target company to resist the hostile takeover attempt. A dead-hand poison pill causes massive dilution of the acquirer’s ownership in the target company. When the hostile acquirer purchases additional shares in the target company, the existing shareholders are automatically issued rights. These rights enable them to buy newly issued shares of the target company at a discounted price.

Shareholder rights plans are generally effective at dissuading a hostile acquirer entirely or forcing the hostile acquirer to increase its offer price. If the target company decides to proceed with the acquisition, the poison pill will be redeemed. The redemption of a poison pill refers to disabling its effects so that the potential acquirer can proceed with the takeover.

If a potential acquirer delivers a formal acquisition proposal to the target company’s board, which is often referred to as a bear hug letter, the board is usually not required to publicly disclose receipt of such letter. If the target company is not interested, it is often advisable to simply reject the acquisition proposal and not engage in further discussions.