This article is written by Amarnath Simha who is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
A takeover means gaining control of the shares/voting rights/ownership of a company called as a target company. A defence strategy for a takeover bid arises only when the management and the main shareholders of the target company are not willing to let go of their control of the target company in favour of the acquirer.
A takeover without the consent, support and recommendation of the management of the target company is called as a hostile takeover. To prevent a hostile takeover or to make it difficult for the acquirer for such hostile takeover, the management of the target company has and can execute certain strategies. However, sometimes, these strategies may also end up affecting the rights, more importantly the value of the stock, of the shareholders of the target companies.
In India in case of a takeover of an unlisted company, it is open to company to adopt all or any of such strategies which are going to be discussed below subject to the provisions of the Companies Act, 2013. But for a listed company, since the number of shareholders who are going to be affected are large and scattered, the Securities and Exchange Board of India (SEBI for short) formulated the Substantial Acquisition of Shares and Takeovers Regulations, 2011 (also called as Takeover code) to protect their interests. In the process, SEBI has provided for certain restrictions which are operative not only against the acquirer company but also against the target company.
Regulation 26 (1) of the Takeover states that the business of the target company shall be carried on by the board of directors of the target company in ordinary course consistent with past practice. Hence, some of the defences which are stated below may not be open to the target company if it is listed. Regulation 26(2) states that the during the offer period, the board of directors of the target company or its subsidiaries shall not, without the approval of the shareholders by a special resolution through postal ballot:
- Alienate any material assets;
- Effect any material borrowings outside the usual course of business;
- Issue or allot any authorised but unissued securities to the holder entitling voting rights;
- Undertake buy back of shares or effect changes to the capital structure;
- Execute, amend or terminate any material contract with the target company;
- Accelerate any contingent right of any person to whom the target company have an obligation including that of employees stock option purchase.
Hence, most of the defences which are stated below may not be open to a listed company even if the articles of association of the target company or the agreements with the target company may provide for the same.
An unlisted company may have all the strategies to execute but on the other hand, the investor may have tag-along or drag-along rights making it either easier or difficult for a hostile takeover.
The strategies which were adopted earlier largely and quite restricted now due to many regulations are numerous in number. New strategies would be invented to meet new situations and hence it is difficult to enumerate them. However, depending on the existing strategies, they could be categorized into three categories:
- Poison Pill Strategies;
- Greenmail Strategy;
- White Knight Strategies;
- Pac-Man Strategy.
Poison-Pill strategies are so named because the target company takes measures to make the target company a bitter pill to swallow for the acquirer company and the acquirer company could end up paying more in the process. Some of these strategies include
Shareholders’ rights program: wherein the existing shareholders are allotted new shares at exceedingly low prices which would attract the existing shareholders to increase their voting rights. This is immediately done after the acquirer announces his intention of takeover. By doing this, the acquirer will be forced to shell out extra money as the stock of the existing shareholders increase.
Voting rights program: The target company may incorporate clauses which prevent the shareholders having more than 20% of the shares from taking a part in certain decisions making them disabled from influencing any takeover bids. The clauses may also be incorporated of the kind wherein the particular decisions will require 80% voting than only 51% voting in case of ordinary decisions. Hence, for the acquirer to get this much voting will find it difficult and will have to work harder.
Staggered Board of Directors: This strategy is enabled to make it difficult for the acquirer to put his nominees on the board of directors even if he is having majority rights. With a particular percentage of board of directors being appointed each year, it would take some time for the acquirer to put his nominees on the board of director and get majority. Hence, it is sought to dissuade him.
Increasing Debt: one of the ways is to increase the debt of the company to make it difficult for the acquirer company to swallow the same.
Buy-back of shares: When the shares of the existing shareholders are bought back at a premium, the resources of the company are used up in the buy back and the acquirer company may find it difficult to acquire at the original price.
Making an acquisition: If the target company acquires another company which is not necessarily required or unnecessary for the acquirer company, the target company has not only used up its resources but also has make it unwieldy for the acquirer company and thereby making it difficult to the acquirer company to acquire without swallowing a bitter pill.
Crown Jewels: In this case, the target company sells of its main profit making undertakings/assets/businesses and thereby makes it difficult to the acquirer to acquire the target company without its main undertakings. Hence, it would be a case of acquirer buying without getting anything in value in return
Scorched Earth: is an extreme case of crown jewels wherein all the undertakings/assets/businesses or as far as possible majority of them are sold and there would be nothing in the target company to be acquired.
Golden Parachute: sometimes, the target company would have entered into employment agreements with the top management wherein they would have been provided an option of large scale payback in case of change of control. Hence, a takeover would mean those clauses would be activated and the acquirer will have to shell out more money to meet those options.
Accelerated vesting of options: are again involving employees wherein the vesting of stock options is allowed to fast forwarded in case of change of control. Hence a takeover would mean that the stock options are vested with employees making it difficult for the acquirer to get control of the company. Moreover, after the takeover, the employees may sell their options and go to different pastures and thereby the acquirer might be losing valuable talent in the process.
Greenmail strategy is where the target company buys off the existing shares of the proposed acquirer at higher prices to prevent him from acquiring the target company. Greenmail is derived from a combination of ‘blackmail’ and ‘greenbacks’ (i.e, American dollar). This is extremely prejudicial to the shareholder as the company’s resources will be used only in preventing the control of the acquirer and not for the benefit of the shareholder. In the process of greenmail, the value of the share falls and consequently the shareholder will have less value.
White Knight Strategies are adopted when the target company approaches a friendly company to buy the shares at a higher price than the acquirer company and thereby still keep the management and control of the target company. There is no threat of hostile control of the board of directors and the shareholders are also benefitted. This can be compared roughly to competing offers which the board of directors of a target listed company have invited. White squire strategy is when a friendly company takes ownership of a portion of the target company and thereby squeezes the acquirer company out of complete control. Thus the acquirer would be left with only an ownership of a smaller portion of the target company without being able to meet its goals.
PAC-Man: is a strategy based on a computer game wherein the hunted gobbles the hunters and becomes the lone person standing. In the same manner, the target company begins to acquire shares of the acquirer company and forces the acquirer company to go on a defensive to protect its interests, like offense is said to be best form of defence. The target company would have turned the tables on the acquirer and in turn would have become the acquirer. This strategy can only be followed when the target company and the acquirer company are almost on equal footing.
Because this strategy would require enormous resources in the standoff and coincidentally a lot of debt is going to be undertaken for this purpose. The shareholder of the target company is never the winner because the debts raised would take many years to be paid off and consequently the dividends would be reduced for so many years.
It is inevitable that many of the strategies are not pro-shareholders of the target company as the company’s resources would be used only in fighting off the acquirer. Hence, SEBI formulated the takeover code containing many restrictions on the target company as enumerated above making most of the defences redundant and thereby protect the interests of shareholders.
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