The concept was first introduced 1982 by a lawyer specialised in mergers and acquisition, Martin Lipton. This perhaps was the major contribution to the corporate law in the whole of 20th century.
Poison pill is a tactic adopted by the target company during a hostile takeover to make the takeover less attractive or too expensive for the acquirers. In essence, this is a defense mechanism, where the substantial acquirers have not taken the approval of the board of the target company and the target company is not willing to lose control. They would rather see the company fail than managed by the acquirers.
Other word for poison pill is Jonestown Defense.
Illustration: Let’s say a start-up Company M, in the business of technology, is very attractive to one of the biggest technology giant L. The promoters of M are not willing to lose control of the Company in the hand of Company L, but L wishes to purchase majority shares in M. The promoters of M decide on a method which will make the process of acquisition very expensive for Company L, hoping that Company L withdraws its intention of buying stocks in Company M.
Various methods of poison pills are issuing dividends making the shares more expensive to buy, increasing the debt in the market which makes the company less attractive, flipping in, where the number of shares held by common shareholders in increased without increasing the shares of the acquiring company which will dilute the share of the acquiring company in the target company.
A real time example of poison pill would be when in 2012 Carl Icahn had bought 9.98% stakes in Netflix. It planned that the for every acquisition of 10% or above by one person or entity, existing shareholders will be given discounted shareholding. This would dilute the shareholding of the acquirer. When Carl Icahn sold close to half of the stocks held in the Company, it terminated the plan effective immediately. Carl Icahn ultimately completely exited the Company.
Recently, during India’s first IT sector hostile takeover of Mindtree by L&T, efforts were made by the Board of Directors of Mindtree to interfere with the acquisition. Firstly, they attempted or at least contemplated buy back of shares. This obviously was not possible because of tightening norms around buy back which do not board of directors to buy back more than 10% without a special resolution and the fact that the debt ratio is to be maintained at 2:1. Further, Mindtree had announced huge dividends payable to the shareholder of Rs. 27 per share denying it to be a poison pill and citing the reason of completion of 20 years and reaching the milestone of revenue worth $ 1 billion.
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