What is a POISON PILL and how does it work? - YouTube

John, let's talk about poison pills, a  particularly famous or infamous tool in  

the arsenal of hostile takeover defense. What is  a poison pill and how does it work? The poison  

pill is tremendously famous. The poison pill was  invented in the 1980s by a man named Marty Lipton,  

who's one of the named partners at the  law firm Wachtel, Lipton, Rosen, and Katz.  

Wachtel basically made itself famous and very very  rich in the 1980s and 1990s defending companies  

against hostile takeovers, and one of the  firm's greatest inventions was the poison pill.  

The poison pill is so named because it's like  the cyanide pill that the pilots of U-2 fighters  

were supposed to take if their plane went down. Oh  wow, so I'll take poison before you can torture me  

from my secrets? That's right. I'm gonna take the  cyanide pill and you'll never get anything out of  

me. Put differently, it's a kind of scorched-earth  strategy. A poison pill is a little complicated,  

but it works very effectively. The basic idea  is this – a company puts a provision in its  

governing documents that says that the board of  directors can issue a form of preferred stock  

giving the existing stockholders the right to  purchase stock at a discounted price upon the  

happening of a certain event, and the event is  the acquisition of a certain number of shares  

by an acquirer. For example, a 15% threshold  for the poison pill to come into effect. Yes,  

if I acquire 17% of the company's shares, then  all of the existing stockholders other than myself  

will get the right to purchase new shares at some  discounted price, sometimes for nothing at all.  

Sometimes for zero dollars. Which would make  buying the company a lot more expensive. Yes,  

because let's say that a company has 100 shares  outstanding, and I have just acquired 15 of them.  

And in so doing, I've triggered a poison pill.  Let's say that the remaining shareholders all get  

another 100 shares for free. Well, now all of a  sudden instead of owning 15 percent of the company  

I own 7.5%. That is to say 15 shares out of  200 total shares outstanding, and moreover  

because all of these existing stockholders  have received their shares for nothing,  

the value of my shares has been effectively  deflated. What if you hit the 15% again, is the  

poison pill triggered a second time. There's some  dispute about this, the reason it's uncertain is  

that poison pills vary. Some poison pills might  be re-triggered, some might not. Additionally  

poison pills have proven so effective that  nobody's ever really triggered one twice.  

So we don't really know for sure what would  happen, but poison pills are highly effective  

because they make it essentially impossible for  anyone to acquire more than a certain number of  

shares. John, you mentioned Marty Lipton, the  lawyer who invented the poison pill. I know  

there are also a lot of very fancy, high-paid  lawyers out there trying to figure out how to  

get around these provisions. What strategies  are there to attempt to overtake a poison pill?  

Yes I spent a lot of time in my classes at  Yale Law school teaching people both how to  

set these things up and how to get around them and  these graduates go on to get paid a lot of money  

to do precisely this. So, poison pills have one  crucial weakness which is that if you gain control  

of the board of directors you can remove it. So,  if I run a proxy contest and I get my candidates  

on the board of directors before I trigger the  poison pill, then they can vote to remove the  

poison pill and pave the way for me to acquire a  lot of shares. Crucially, I have to get control of  

the board of directors before I actually trigger  the pill because once the shares, once the rights  

to acquire shares are out there in the hands of  shareholders and once they've been triggered,  

the board can't unilaterally take them back. And  I should say that the poison pill is especially  

vicious because every company in the United  States has one implicitly. What do you mean  

by that? A company can basically adopt a poison  pill overnight or really in a matter of minutes.  

All that has to happen is the board of directors  resolves to do the sorts of things that would  

involve the adoption of a poison pill so even if  a company doesn't have a poison pill right now  

it could have one 10 minutes from now by just  getting on the phone and calling its lawyers.  

So, as a practical matter every single company  in the United States effectively has one.