Pre-offer Defense Mechanisms
Pre-offer defense mechanisms are used by managers to resist a hostile takeover of the company they manage. Managers can be very creative to resist such takeovers. These measures can be divided into two kinds of defenses: pre-offer defenses and post-offer defenses. As the terms imply, defensive measures can be taken either before or after a hostile offer takes place, but most M&A legal experts recommend that defenses are set up before an offer occurs, because pre-offer defenses tend to face less scrutiny in court.
On this page, we will discuss pre-offer defense mechanisms. Post-offer defense mechanisms are discussed here.
Poison pills are extremely effective anti-takeover devices and were subject of many legal battles in their infancy. In its most basic form, a poison pill gives current shareholders the right to purchase additional shares of stock at extremely attractive prices, which causes dilution and effectively increases the cost to the potential acquirer. The pills are usually triggered when a shareholder’s equity exceeds some threshold level (e.g. 10%).
Specific forms of a poison pill are:
- a flip-in pill, where the target company’s shareholders have the right to buy the target’s shares at a discount
- a flip-over pill, where the target’s shareholders have the right to buy the acquirer’s shares at a discount
In the case of a friendly merger, most poison pill plans give the board of directors the right to redeem the pill prior to a triggering event.
This anti-takeover device is different from the others, as it focuses on bond holders. These puts give bondholders the option to demand immediate repayment of their bonds if there is a hostile takeover. This additional cash burden may fend off a would-be acquirer.
Restrictive takeover laws
Companies in the United States are incorporated in specific states, and the rules of that state apply to the corporation. Some states are more target friendly than others when it comes to having rules to protect against hostile takeover attempts. Companies that want to avoid a potential hostile merger offer may seek to reincorporate in a state that has enacted anti-takeover laws. Historically,
In this strategy, the board of directors is split into roughly three equal-sized groups. Each group is elected for a 3-year term in a staggered system: in the first year the first group is elected, the following year the next group is elected, and in the final year the third group is elected. The implications are straight-forward. In any particular year, a bidder can win at most one-third of the board seats. It would take a potential acquirer at least two years to gain majority control of the board.
Restricted voting rights
Equity ownership above some threshold level (e.g. 15% or 20%) triggers a loss of voting rights unless approved by the board of directors. This greatly reduces the effectiveness of a tender offer and forces the bidder to negotiate with the board of directors directly.
Supermajority voting provision for merges
A supermajority provision in the corporate charter requires shareholders support in excess of a simple majority. For example, a supermajority provision may require 66.7%, 75% or 80% of the votes in favor of a merger. Therefore, a simple majority shareholder vote of 51% would still fail under these supermajority limits.
Fair price amendments
A fair price amendment restricts a merger offer unless a fair price is offered to current shareholders. This fair price is usually determined by some formula or independent appraisal.
Golden parachutes are compensation arrangements between the target and its senior management that gives the managers lucrative cash payouts if they leave the target company after a merger. In practice, the payouts to managers generally are not big enough to stop a large merger deal, but they do ease the target management’s concern about losing their jobs.
We discussed pre-offer defense mechanisms. On this page, we discuss post-offer mechanisms page.