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What Is a Poison Pill?

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We're not talking about cyanide capsules. We're talking about a shareholder rights plan. 

A poison pill—in the business world—is a device that a company can implement to prevent a potentially hostile investor from rapidly accumulating too much stock in the company. 

In 2020, there have been plenty of opportunities for investors to acquire large positions on the cheap in a company whose stock has plummeted as a result of the coronavirus. For context, some companies entered the pandemic with high debt burdens and out-dated business models and may be ripe for a turnaround of strategy or a sale to a buyer. So investors seek to accumulate large positions in those companies at relatively low prices. 

Those investors may want to achieve control of the company by buying a large percentage of the shares in the open market or even by initiating an unsolicited offer to buy the whole company.  

The hostile bidder may seek to initiate a tender offer. That's when an investor directly offers to buy enough stock from other shareholders to gain control of the company, or at least 51% of the shares. But the investor is doing this against the recommendation of management, which may see a promising future in the company as it is. 

Most friendly acquisitions occur at a substantial premium to the market price, as the buyer will gain operational control of the company. But a poison pill seeks to protect shareholder value by preventing a hostile investor from taking control of the company without paying an adequate control premium. 

So the target company adopts a poison pill to prevent the acquirer from getting additional shares in the company. 

Normally, the company states that if any investor passes a specified level of ownership in the company (usually 10% or 15%), the pill is triggered. If the pill is triggered, the company issues the right to redeem new shares to all shareholders except for the shareholder that triggered the pill by crossing the threshold. This dilutes the hostile bidders' position, disabling it from owning a larger percentage of the shares and preventing it from gaining additional influence over the company.  

Curious about how many pills have been adopted this year and what the recent increase has looked like? Watch the quick video above. 

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