Poison pills take a wide variety of forms, but today most are based on the class of security known as a right. Hence, the pill's official name, the "shareholder rights plan." A traditional right, such as a warrant, grants the holder the option to purchase new shares of stock of the issuing corporation. The modern poison pill adds two additional elements not found in traditional rights: "flip in" and "flip over" provisions.
Rights are corporate securities that give the holder of the right the option of purchasing shares. Because issuance of rights does not require shareholder approval, a rights based pill may be adopted by the board of directors without any shareholder action. When adopted, the rights initially attach to the corporation's outstanding common stock, cannot be traded separately from the common stock, and are priced so that exercise of the option would be economically irrational. The rights become exercisable, and separate from the common stock, upon a so called distribution event, which is typically defined as the acquisition of, or announcement of an intent to acquire, some specified percentage of the issuer's stock by a prospective acquirer. (Twenty percent is a commonly used trigger level.) Although the rights are now exercisable, and will remain so for the remainder of their specified life (typically ten years), they remain out of the money.
The pill's flip over feature typically is triggered if, following the acquisition of a specified percentage of the target's common stock, the target is subsequently merged into the acquirer or one of its affiliates. In such an event, the holder of each right becomes entitled to purchase common stock of the acquiring company, typically at half price, thereby impairing the acquirer's capital structure and drastically diluting the interest of the acquirer's other stockholders. In other words, once triggered, the flip over pill gives target shareholders the option to purchase acquiring company shares at a steep discount to market. This causes dilution for the bidder's pre-existing shareholders and may have undesirable balance sheet effects.
In a flip in plan, rights again are issued and become exercisable upon the same sort of triggering events. The difference between the two plans is that the flip in plan enables shareholders of the target to purchase target stock at a discount. Today, they are usually adopted in tandem with flip over plans.
The flip in element is typically triggered by the actual acquisition of some specified percentage of the issuer's common stock. (Again, 20 percent is a commonly used trigger.) If triggered, the flip in pill entitles the holder of each right - except, and this is key, the acquirer and its affiliates or associates - to buy shares of the target issuer's common stock or other securities at half price. In other words, the value of the stock received when the right is exercised is equal to two times the exercise price of the right. The flip in plan's deterrent effect thus comes from the dilution caused in the target shares held by the acquirer. For example, in Grand Metropolitan's bid for Pillsbury, Pillsbury's flip in plan would have reduced Grand Met's interest in Pillsbury from 85% to 56 percent. The value of Grand Met's holdings would have declined by more than $700 million dollars.
For further discussion, see my article Dead Hand and No Hand Pills or my book Mergers and Acquisitions.
