Also known as a shareholder rights plan, a poison pill is a defensive measure used by public companies to defend against hostile takeover attempts by third parties. A typical poison pill gives all shareholders other than the unwelcome acquiror or hostile bidder the right to buy additional stock, either in their own company or the acquiror, at a substantial discount. The purchase rights are typically triggered when a person announces the purchase, or an intention to buy, stock over a specified percentage, commonly 15% or 20% of the target company's stock.
Companies typically adopt a poison pill when they are concerned about their vulnerability to a hostile takeover attempt or, in certain cases, have significant net operating losses (www.practicallaw.com/8-382-3642) (NOLs). Once the poison pill is triggered, the acquisition can become very expensive for the prospective acquiror, and any target company stock previously purchased by that acquiror becomes significantly diluted.
The two most common types of rights plans are:
"Flip-in" plans, which give the target company's shareholders the right to purchase additional target company stock (typically on a one-for-one basis) at the discounted price.
"Flip-over" plans, which give the target company's shareholders the right to purchase stock of the acquiring company at a discounted price.
For more information on the use of poison pills to prevent hostile takeovers, see Practice Notes, Poison Pills: Defending Against Takeovers and Protecting NOLs (www.practicallaw.com/3-386-0340) and Defending Against Hostile Takeovers (www.practicallaw.com/9-386-7206).