What is a Hostile Takeover?

Key takeaways

• A hostile takeover occurs when a company is acquired without the consent of its board of directors.

• A tender offer and a proxy fight are two methods in accomplishing a hostile takeover.

• Target companies can use certain defenses, such as poison pills or crown jewels, to ward off hostile takeovers.

Understanding hostile takeover

A hostile takeover occurs when a company is acquired without the consent of its board of directors. The company being acquired in a hostile takeover is the target company, while the one executing the takeover is the acquirer.

A hostile takeover is the opposite of a friendly takeover, in which both parties agree to the transaction and work cooperatively toward the result.

Hostile takeovers first began to gain popularity in the 1980s. Over the decade, hundreds of unsolicited takeover attempts took place, and companies lived in fear that such a thing might happen to them.

Three primary strategies can be used to complete a hostile takeover: buying the company's stock from open markets, a tender offer and a proxy fight.

• Buying the target company's stock from open markets

The acquirer buys a majority of the available shares of the target company on the open market, thus taking control of the target. This may not always be possible as the majority of shares may be in the hands of the board of directors, which means not many outstanding shares available on the open market.

• Tender offer

A tender offer is when the hostile bidder bypasses the company's board of directors and offers to purchase shares directly from shareholders, usually at a premium above the current market value.

Each shareholder decides for themselves whether to sell their stakes in the company. The bidder's goal is to buy enough shares to have a controlling stake in the company.

A famous example of a tender offer took place in 2010 when the French biotech company Sanofi-Aventis offered to purchase the US biotech company Genzyme to expand into a niche industry and broaden its product offering.

Genzyme's leadership declined, so Sanofi took its bid directly to the shareholders, paid a premium for the shares, added in contingent value rights, and acquired Genzyme.

• Proxy fight

A proxy fight refers to the act of a group of shareholders joining forces and attempting to gather enough shareholder proxy votes to win a corporate vote. In a hostile takeover, outside acquirers may attempt to convince existing shareholders to vote out some (or all) of a company's senior management to make it easier to seize control over the organization.

An example of a proxy fight was between Microsoft and Yahoo in 2008. Microsoft had offered to purchase Yahoo, but Yahoo's board rejected the offer as it felt the company was undervalued. In return, Microsoft initiated a proxy fight, trying to field its own directors to Yahoo's board. The takeover was ultimately unsuccessful as Microsoft abandoned its goal of acquiring Yahoo in just a few months.

How do companies prevent hostile takeovers

Many companies have developed defensive strategies to help prevent hostile takeovers. These strategies are designed to make the takeover more difficult, more expensive, or less attractive to the hostile bidder. Here are three strategies to help prevent a hostile takeover:

• Differential Voting Rights (DVRs)

A company can establish stock with differential voting rights (DVRs) to protect against hostile takeovers. Different voting power is given to certain shares, making it more challenging to generate the votes needed for a hostile takeover if management owns a large enough portion of shares with more voting power.

• Crown Jewel

In a crown jewel defense, a provision of the company's bylaws requires selling the most valuable assets in case of a hostile takeover, making it less attractive as a takeover opportunity. This is often considered one of the last lines of defense.

• Poison Pill

This defense tactic is officially known as a shareholder rights plan.

The most common type of poison pill is known as a flip-in poison pill, which is automatically triggered when a hostile bidder gains a certain percentage of shares in the target company.

The flip-in poison pill gives all shareholders except for the hostile bidder the right to purchase additional shares at a discounted price.

This move dilutes the hostile bidder's ownership in the company by flooding the market with shares. As a result, it becomes more expensive to take over the company.

While they're effective at preventing hostile takeovers, poison pills can be disadvantageous for individual investors. They flood the market with new shares, diluting the ownership of all shareholders and thus requiring investors to spend more money to maintain their current stake in the company.

What it means for individual investors

You could be affected by a hostile takeover as an investor, but the exact impact is unique to each situation.

First, hostile takeovers aren't necessarily harmful to shareholders. They may increase the share prices of the target when the takeover news spreads.

Second, since hostile takeovers often involve the hostile bidder buying shares at a premium, this type of transaction could be profitable for the original shareholders.

However, after the hostile takeover, it's hard to predict the long-term effects on the company's performance and share prices.