A shareholder rights plan, also known as a “poison pill”, is one of the most effective defense tactics available to publicly traded corporations. A poison pill is designed to make the transaction being pursued by a hostile bidder extremely unattractive from an economic perspective, compelling the bidder to negotiate with the target’s Board of Directors.
Generally, a poison pill issues rights to all existing shareholders, with the exception of the hostile suitor, to acquire stock of the target (or of the aggressor upon a subsequent merger) at prices significantly below market. These rights are triggered by certain specified events, such as the announcement of a cash tender offer or the acquisition by an outsider of a specified percentage of the target’s shares. Thus, a poison pill is effective because it dilutes the economic interest of the hostile suitor in the target, making the transaction both economically unattractive and impractical if pursued on a hostile basis.
Mechanics of a Rights Plan
A typical rights plan follows a distinct sequence: adoption, distribution (if triggered), redemption, and expiration. Adoption of the plan only requires a vote by the Board of Directors. Typically, the Board approves an issue of one right for each outstanding share of its common stock. Once approved, each right entitles the holder, upon occurrence of certain events, to purchase common or participating preferred stock of the company (“flip-in”) or common stock of the acquirer (“flip-over”) at a predetermined exercise price. The rights initially are attached to and trade with the company’s common stock. Currently, the most widely used poison pills are “call plans” that combine the following features:
- “Flip-In” of Right to Purchase Additional Shares of the Company – Upon the acquisition of a specified percentage (generally 10-20% of the company’s outstanding common stock), each right, excluding those held by the acquirer, entitles its holder, upon payment of the exercise price, to acquire shares of the company’s common stock or participating preferred stock having a market value, on the date of the transaction, equal to some multiple (generally 2x) of the right’s exercise price.
- “Flip-Over” of Right to Acquire Shares of the Acquirer – Upon a merger, consolidation (in which the company’s common stock is changed or exchanged) or sale of at least some stated percentage (usually 50%) of the company’s assets or earning power, each right, excluding those held by the acquirer, entitles its holder, upon payment of the exercise price, to acquire shares of the acquirer having a market value on the date of the merger, consolidation, or sale equal to some multiple (generally 2x) the right’s exercise price.
Determining the Exercise Price
The exercise price is set by the Board with the help of its financial advisors. The setting of the exercise price is designed to neither put a transaction value on the company nor reflect an appropriate acquisition price. Rather, the exercise price is determined by estimating the long-term trading value of the company’s common stock during the life of the rights plan. Usually, the exercise price is in the range of 3-5x the company’s current stock price at the time of adoption, though multiples have risen recently due to generally depressed stock prices. The exercise price as a multiple of the company’s stock price is higher for companies with high growth potential or companies where current operating performance is depressed, and it is lower for more established companies in mature industries. The development of an exercise price should not be based on the average of other companies’ rights plans but, rather, on the characteristics of the company itself.
General Terms of “Call Plans”
- Amendment – The rights plan may be amended or supplemented without the approval of any holders of the rights, so long as they are redeemable and, thereafter, if the holders of the rights are not adversely affected.
- Distribution – One right is distributed as a dividend on each outstanding share of common stock.
- Distribution of Rights (“Distribution Date”) – Rights are distributed upon (i) a number of days (typically ten) following the date the Board becomes aware that an individual or group has acquired beneficial ownership of at least some stated percentage (usually 10-20%) of the company’s common stock or (ii) a number of days (typically ten business days) following the commencement of a tender or exchange offer for at least some stated percentage (usually 10-20%) of the company’s outstanding shares of common stock.
- Exchange – A Board may elect to have a “cashless” exchange of one right for one share of common stock or a “spread”.
- Exercise Price – Usually 300-500% of the current market value of the company’s common stock; exercise price is based on the potential long-term value of the company’s common stock during the term of the rights.
- Redemption – Rights are redeemable at a nominal price (usually between $0.01 and $0.05 per right) at the option of the company prior to an acquirer gaining control or the expiration of a “window period” (typically 10 days) thereafter.
- Share Purchase Right – Each right, after becoming exercisable, entitles its holder to purchase a unit consisting of some fraction of a share or participating preferred stock or a share of common stock of the company at the exercise price.
- Term – Rights expire at some stated time after issuance (usually 10 years).
- Transferability – Rights are not detachable from the company’s common stock until the distribution date; after the rights detach, separate rights certificates are issued and the rights trade separately from the company’s common stock.
- Voting – Rights have no voting power.