Rev Rul 90-11, 1990-1 CB 10 provides that when a publicly held corporation adopts a plan providing shareholders with rights to buy additional stock at less than fair market value to head off any unsolicited take-over attempt, it is termed a “poison pill” plan. Generally, a poison pill is a type of financial or structural maneuver that a company may make to frustrate an attempted takeover by a hostile bidder. An acquiring company will abandon its takeover and allow the target company to remain independent, if the poison pill is effective.
Poison pills have existed in various forms for many decades. They were viewed merely as anomalies in corporate finance. Poison pills typically discourage hostile takeovers by letting companies sell large amounts of stock to existing shareholders at cheap prices. The hostile bidder is not allowed to purchase any of the new stock. His/her holdings in the takeover target become diluted and are worth less.
The most common type of poison pill is the shareholder rights, or “flip-over” plan. It allows a company facing an unwelcome bid to declare a special stock dividend consisting of rights to purchase additional, new shares. In order to make a suitor company spend substantially more to acquire control, the price to these rights is purposely set far above market value. The company may redeem the rights after the bid has been abandoned.
The shareholder rights may be transferred or “flipped over” to the successor firm, if the takeover bid is successful. These rights entitle the shareholders to purchase shares in the surviving firm at a discount of as much as 50 percent. This causes tremendous dilution of the surviving firm.
The “flip-in” plan is a variation of the flip-over plan. It hastens the exit of a suitor with a substantial minority of shares, without affecting a merger. The flip-in offers the company rights to buy additional discounted shares in the target.
Poison pill plans enable a company to thwart everyone except the most determined and deep-pocketed suitors. It allows shareholders to benefit greatly if the suitor succeeds. Moreover, no poison pill or any other type of defense is ever meant to be used. Poison pills indicate to the financial community that the companies using them suffer from some financial or structural weakness and are ready for some form of merger.
Another type of poison pill is “deadhand” poison pill. Dead-hand poison pills can be redeemed only by the incumbent board of directors. Such a plan is designed to keep the existing board and current management in place, at the expense of existing shareholders or in opposition to a majority of shareholders. It eliminates shareholders’ ability to act by written consent. A variation on the dead-hand poison pill is the no-hand poison pill. It cannot be altered for at least one year or some specified time.