Staying In Control: Tactics To Protect Your Company From Hostile Takeovers

As an entrepreneur, how would you protect your company from hostile takeovers? Typically, takeovers are legitimate business transactions and are also referred to as mergers and acquisitions (M&A). As a rule, M&As are strategic partnerships that companies enter into.

Their objective is to achieve value-driving synergies that propel accelerated growth and benefit all the participants. Merging or acquiring partners hope for higher cost efficiencies, increased revenues, and economizing on operating expenses and applicable taxes.

Horizontal or vertical M&As for expansion within the sector or into complementary verticals are also a goal. Then again, cross-border acquisitions help companies expand into broader geographical areas and capture a bigger customer base in new markets.

When designed as tactical approaches, acquisitions can have multiple advantages for companies. But if they enter into the transaction voluntarily. Hostile takeovers occur when third parties attempt to acquire a company against the wishes of its shareholders by using underhanded means.

In other words, a hostile takeover is an involuntary acquisition of a company’s assets or shares. As the owner, you should be aware of the warning signs. Stay one step ahead of such risks and prepare to protect your company. Read ahead to learn how you can make that happen.

Understanding How Hostile Takeovers Happen

Companies of any size and operating within any sector can face a hostile takeover. An acquirer can purchase a large chunk of the company’s shares without the consent or knowledge of its board. As a result, they also gain a controlling (over 50%) stake in the company, along with voting rights.

Once that happens, the acquirer can make the key decisions and override the board, shareholders, founders, or the CEO. Since they can dictate the new corporate policy, they have the power to remove the existing board and/or CEO.

Depending on their objectives from the transaction, they can liquidate the target company’s assets or put it out of business. Hostile takeovers can take the form of horizontal or vertical acquisitions, as well as conglomerate mergers and acquisitions (M&As).

In some cases, a hostile M&A can also work to safeguard the company from ineffective management or redundant founders. When that happens, the acquiring entity may appoint an entirely new board of directors and CEO. Their objective is to lead the company toward profitability and success.

Most hostile takeovers are designed to eliminate a strong competitor and integrate its operations with those of the acquirer. Taking over a company for its exceptional talent, skill sets, and intellectual property is another strategy a competitor can adopt.

Why Hostile Takeovers Occur

Hostile takeovers occur when attempts for a friendly merger or acquisition deal (M&A) are unsuccessful. The acquirer may employ underhanded methods to take over the company. Their goals involve accessing or owning the target’s brand name, assets, and technology.

The acquirer may also want control of the target’s intellectual property, market reach, geographical foothold, or talent, as in acquihires. It employs strategies such as making a tender offer to acquire a controlling stake in the target. It purchases shares at a price well above the current market value.

One such example is that of Sanofi’s acquisition of Genzyme. Sanofi, a pharmaceutical giant, was interested in buying Genzyme, which produced drugs for the treatment of rare genetic disorders. Eventually, the giant successfully closed the deal by offering shareholders premium share prices and contingent value rights.

At times, the shareholders may feel that the company is significantly undervalued. As a result, active stakeholders seeking a change in management may oust the board and replace it with new members. By exercising their voting rights, shareholders vote out the existing board and vote in new members.

This is another form of a hostile takeover, occurring when shareholders are dissatisfied with the board’s decisions. And, the company’s performance under their management. In this instance, the hostile takeover takes the form of a proxy fight.

Venture capitalists (VC) having board seats and controlling rights use this strategy to steer the company in a desired direction. It’s not uncommon for founders holding the position of CEO to be forced to step down. They are relegated to less important positions or ousted entirely.

One of the most famous examples is of Apple’s co-founder Steve Jobs. in 1985, after disagreements over strategy with the board of directors and then-CEO John Sculley, Steve Jobs lost his position.

Strategies to Protect Your Company from Hostile Takeovers

Company founders can adopt different strategies to protect their companies from hostile takeovers. Here’s a quick dive into your options:

Williams Act of 1968

Before discussing the Williams Act, let’s first understand how tender offers work. One form of hostile takeovers is when the acquiring entity makes a tender or direct offer to the target’s shareholders. It may offer cash in exchange for a sizeable chunk of shares.

Typically, they make this offer without the company’s management’s approval, despite its opposition to the deal. To protect companies from such takeover bids, the US Congress passed the Williams Act in 1968. Here are some of its key provisions:

• The law applies to any takeover bids in which the acquirer offers to purchase shares at rates 15% to 20% above market value.
• Acquiring entities are required to provide the Securities and Exchange Commission (SEC) and the target’s shareholders with complete information.
• The acquirer must disclose the source of the funds it will use to pay the shareholders.
• It must also reveal the key objectives for making the tender offer.
• It must disclose the intended plans for the acquired company, should the offer be successful and the transaction be closed.
• The acquiring entity may have entered into any contracts or deals that it intends to execute after the purchase. It must present this information to the SEC and shareholders.
• The Williams Act is also applicable to any tender offers made to purchase 5% or more of the target’s outstanding stock.
• It sets a timeline that includes the minimum number of days shareholders have to make their decision.
• It prevents false, misleading, and incomplete information from reaching shareholders and influencing their judgment.

With this act, regulating authorities attempted to enforce greater transparency regarding the potential outcomes of the transaction. The objective was to ensure that shareholders have sufficient time and adequate information to make informed decisions.

Why the Williams Act Needs Updates

As the company owner, you can leverage the law to protect your company from such bids. You’ll communicate with shareholders and potentially reverse the hostile takeover before it occurs.

While the Williams Act can protect your company from hostile takeovers, know that many of its provisions are now obsolete. At the same time, the availability of information enables stakeholders to carefully weigh their options and consider the offer.

For example, the acquiring entity has a proven track record of successfully acquiring companies and turning them around. In that case, the takeover could be beneficial even if the management and board are not in favor of it. Maintaining a balance is crucial, and the law ensures that.

It is also essential to understand that the shareholder demographics of publicly traded companies have undergone significant changes. Since the law was passed, over the last 60 years, the availability of real-time information has changed how shareholders make investment decisions.

Experts also argue that more investors prefer to invest in derivative securities, which changes the mechanisms of hostile takeover bids.

Staggered Board Defense

You can protect your company from hostile takeovers by adopting the staggered board defense. This strategy splits the board into different classes, creating a classified board. Typically, the board then has three classes with only one coming up for re-election at a time.

Since the board composition changes over a staggered period, voting them out becomes a complex and time-consuming process. Particularly since most board members have overlapping terms. As a result, third-party acquirers find it challenging to appoint their own directors.

White Knight Defense

The White Knight defense is a strategy boards deploy when they cannot avert a hostile takeover. In this case, it invites a friendly firm to purchase a controlling stake in the company, outbidding the hostile acquirer.

The friendly firm, or White Knight, agrees to purchase the target’s stock at premium prices above the hostile’s offer. As part of the deal, the White Knight may agree to restructure the target company per the board’s requirements.

Greenmail Defense

The Greenmail Defense involves repurchasing the acquirer’s shares in your company, possibly at a substantial premium. As a result, the acquirer loses its stake and must abandon its attempts at a hostile takeover.

A good example is the 1986 instance where Sir James Goldsmith threatened a hostile takeover of Goodyear. He held an 11.5% stake in the company, which responded with a Greenmail defense tactic. It repurchased Goldsmith’s shares at a premium price, thus averting the bid while yielding a profit.

Although an effective strategy, this anti-hostile takeover approach is not as widely used. That’s because the profits from the sale of stock in such deals are subject to capital gains tax.

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Crown Jewel Defense

To use this strategy, you’ll incorporate the provisions in the company’s bylaws. In the event of a hostile takeover bid, you can then sell the company’s most valuable assets or Crown Jewels. This tactic diminishes the company’s value, making is less attractive as an acquisition.

Most companies use this move as a last-ditch effort to prevent the takeover, specifically targeting the acquirer’s interests. They sell the assets driving the acquirer’s bid.

Poison Pill Defense

Also referred to as a shareholders’ rights plan, the poison pill defense is about diluting the acquirer’s owned stake. Accordingly, the company offers existing shareholders the opportunity to purchase newly-issued shares at a discounted price.

The condition they lay down is that the shareholder should buy more than a specific percentage of stock. However, the acquirer threatening the takeover does not get this opportunity. As a result of the fresh issue, the acquirer faces a significant dilution in their stake, negating their advantage.

Issuing Stock with Differential Voting Rights

Company owners and the management typically deploy this strategy when issuing new shares. All new issues don’t carry the same voting rights. Some classes may have fewer rights, for example, the holder gets one vote per 100 shares they own.

You can restrict greater voting power to the management. Thus, you’ll make it harder for acquirers to gain controlling rights in the company. They just won’t have enough shares. To compensate holders for fewer voting rights, you can offer higher dividends, making the shares attractive investments.

Employee Stock Ownership Plan

Interestingly, offering employees stock options is an effective strategy to protect your company from hostile takeovers. Since employees are part owners of the company, they have a vested interest in protecting its ownership. They are more likely to align with the management’s decisions.

Employees are also less likely to sell their stock to third parties. You can always include the provision of repurchasing stock that exiting employees own when they exit the company. Offering fair market value ensures that they are well compensated for their work in the company.

Other Effective Strategies

Additional tactics to protect your company from hostile takeovers include the Golden Parachute and Pac-Man defenses. In the case of the Golden Parachute, you’ll plan for generous severance packages for top-tier company executives. But, in the event of a hostile takeover.

Accordingly, the team receives benefits such as severance pay, bonuses, stock options, continued health benefits, and more. These perks entice them to remain with the company during periods when the company is facing instability.

As for the Pac-Man defense, the target company actively and aggressively starts purchasing stock in the acquirer’s company. If it can gain an adequate stake and controlling rights, it will prevent the takeover from occurring.

Yet another approach is to include Supermajority Amendments in the company’s bylaws. These clauses require a supermajority or 66.67% or 75% of shareholders to vote in favor of the takeover. Only then can it be executed.

With the right strategies and the advice of your expert legal counsel, you can take the necessary preventive steps. Safeguard your company from the possibility of hostile takeovers, preferably by including the right preemptive clauses in its bylaws.

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