Poison Pill

When the board adopts a rights plan, it distributes 'rights' to all existing shareholders. These rights lie dormant until a triggering event — typically a hostile acquirer crossing the threshold (say 15%) of outstanding shares. At that point the rights become exercisable, letting every shareholder EXCEPT the hostile acquirer buy new shares at roughly a 50% discount. Because the acquirer is excluded, its percentage ownership is slashed and the cost to reach control balloons. The board retains the power to redeem the rights cheaply (e.g., $0.01 each) if it later approves a deal — which is precisely why hostile acquirers pair a pill challenge with a proxy fight to replace the board.

A flip-in pill lets target shareholders (other than the acquirer) buy discounted shares of the TARGET, diluting the acquirer's stake in the company it's trying to buy. This is the most common form. A flip-over pill kicks in after a merger is completed and lets target shareholders buy discounted shares of the ACQUIRER (the surviving entity), diluting the acquirer's own existing shareholders. Many modern plans contain both. A newer variant, the 'NOL pill,' is set at a much lower threshold (often ~4.99%) to protect a company's net operating loss carryforwards from being limited under tax rules when ownership changes too fast.

A pill is powerful but not absolute. The board can always redeem it, so a determined acquirer runs a proxy fight to install directors who will pull the pill — which is why a pill is most effective when paired with a staggered board that prevents replacing a majority of directors in a single election. Courts (especially Delaware, via Unocal and Moran v. Household) permit pills only as a 'reasonable response' to a threat, not as permanent entrenchment, and proxy advisors (ISS, Glass Lewis) often recommend voting against boards that adopt long-term pills without a shareholder vote. Many companies today keep a pill 'on the shelf,' ready to adopt within hours if a hostile bid emerges.