Hostile Takeover

What Is Hostile Takeover?

The term hostile takeover refers to the acquisition of one company by another corporation against the wishes of the former. The company being acquired in a hostile takeover is called the target company while the one executing the takeover is called the acquirer. In a hostile takeover, the acquirer goes directly to the company's shareholders or fights to replace management to get the acquisition approved. Approval of a hostile takeover is generally completed through either a tender offer or a proxy fight.

Understanding Hostile Takeovers

Factors playing into a hostile takeover from the acquisition side often coincide with those of any other takeover, such as believing that a company may be significantly undervalued or wanting access to a company's brand, operations, technology, or industry foothold. Hostile takeovers may also be strategic moves by activist investors looking to effect change on a company's operations.

The target company's management does not approve of the deal in a hostile takeover. This type of bid occurs when an entity attempts to take control of a firm without the consent or cooperation of the target firm's board of directors. In lieu of the target company's board approval, the would-be acquirer may then:

When a company, investor, or group of investors makes a tender offer to purchase the shares of another company at a premium above the current market value (CMV), the board of directors may reject the offer. The acquirer can approach the shareholders, who may accept the offer if it is at a sufficient premium to market value or if they are unhappy with current management. The Williams Act of 1968 regulates tender offers and requires the disclosure of all-cash tender offers.

In a proxy fight, opposing groups of stockholders persuade other stockholders to allow them to use their shares' proxy votes. If a company that makes a hostile takeover bid acquires enough proxies, it can use them to vote to accept the offer.

The sale of the stock only takes place if a sufficient number of stockholders, usually a majority, agree to accept the offer. 

Defending Against a Hostile Takeover

To deter the unwanted takeover, the target company's management may have preemptive defenses in place, or it may employ reactive defenses to fight back.

Differential Voting Rights (DVRs)

To protect against hostile takeovers, a company can establish stocks with differential voting rights (DVRs), where a stock with less voting rights pays a higher dividend. This makes shares with a lower voting power an attractive investment while making it more difficult to generate the votes needed for a hostile takeover if management owns a large enough portion of shares with more voting power.

Employee Stock Ownership Program (ESOP)

Establishing an employee stock ownership program (ESOP) involves using a tax-qualified plan in which employees own a substantial interest in the company. Employees may be more likely to vote with management. As such, this can be a successful defense.

Crown Jewel

In a crown jewel defense, a provision of the company's bylaws requires the sale of the most valuable assets if there is a hostile takeover, thereby making it less attractive as a takeover opportunity.

Poison Pill

This line of defense is officially known as a shareholder rights plan. It allows existing shareholders to buy the newly issued stock at a discount if one shareholder has bought more than a stipulated percentage of the stock, resulting in a dilution of the ownership interest of the acquiring company. The buyer who triggered the defense, usually the acquiring company, is excluded from the discount.

The term poison pill is often used broadly to include a range of defenses, including issuing additional debt, which aims to make the target less attractive, and stock options to employees that vest upon a merger.

Other Strategies

Sometimes a company's management will defend against unwanted hostile takeovers by using several controversial strategies, such as the people poison pill, a golden parachute, or the Pac-Man defense.

A people poison pill provides for the resignation of key personnel in the case of a hostile takeover, while the golden parachute involves granting members of the target's executive team with benefits (bonuses, severance pay, stock options, among others) if they are ever terminated as a result of a takeover. The Pac-Man defense has the target company aggressively buy stock in the company attempting the takeover.

Hostile Takeover Examples

A hostile takeover can be a difficult and lengthy process and attempts often end up unsuccessful. For example, billionaire activist investor Carl Icahn attempted three separate bids to acquire household goods giant Clorox in 2011, which rejected each one and introduced a new shareholder rights plan in its defense. The Clorox board even sidelined Icahn's proxy fight efforts, and the attempt ultimately ended in a few months with no takeover.

How Is a Hostile Takeover Done?

A hostile takeover bid occurs when an entity attempts to acquire control of a publicly traded company without the consent or cooperation of the target's board of directors.

The would-be acquirer has three options to wrest control. The first is a tender offer, which requires a majority of the shareholders to accept, the second is a proxy fight, whose goal is to replace enough of the uncooperative board members, and the third is to buy the necessary company stock in the open market.

How Can Management Preempt a Hostile Takeover?

To protect against hostile takeovers, a company can establish stocks with differential voting rights, where a stock with less voting rights pays a higher dividend. This makes these lower voting power shares an attractive investment, making it more difficult to generate the votes needed for a hostile takeover, especially if management owns a large enough portion of them.

Another defense is to establish an employee stock ownership program, which is a tax-qualified plan in which employees own a substantial interest in the company. Employees may be more likely to vote with management, which is why this can be a successful defense.

What Is a Poison Pill?

Officially known as a shareholder rights plan, a poison pill is a common defense against a hostile takeover. There are two types of poison pill defenses, which are called the flip-in and flip-over.

A flip-in is more common, allowing existing shareholders the right to buy newly issued stock at a discount if one shareholder (acquirer) amasses a certain threshold percentage of shares of the target company. This results in a dilution in the ownership interest of the acquiring company. The acquirer is excluded from the discount.

A flip-over poison pill strategy allows stockholders of the target company to purchase the shares of the acquiring company at a deeply discounted price if the hostile takeover attempt is successful, thereby diluting the equity in the acquiring company.

What Are Other Defenses to a Hostile Takeover?

Other strategies to defend against unwanted hostile takeovers include the crown-jewel defense, golden parachute, and the Pac-Man defense.  

In a crown jewel defense, a provision of the company's bylaws requires the sale of the most valuable assets if there is a hostile takeover, thereby making it less desirable to the acquirer.

Golden parachutes consist of substantial benefits given to top executives which, in the event of a takeover, might discourage the acquirer because of the associated costs.

A Pac-Man defense involves the target company turning the tables and aggressively buying stock in the acquirer's company.