What is a hostile takeover/merger? What are the different types of defence strategies followed.

In case of a hostile merger, one which is opposed by the target company's management, the acquirer may decide to circumvent the target management's objections by submitting a proposal directly to the Board of Directors of a target company, bypassing its CEO and this tactic is called a bear hug. Post the bear hug, there could be two routes. One route is where the target management will reconsider its decision and enter in to negotiations, which is unlikely, post which this takes the path of the friendly merger. The other route is that a bear hug doesn't work, in which case the acquirer may contemplate reaching out to the shareholders of the target company directly. Once the hopeful acquirer has taken a decision to reach out to the shareholders of the target company directly, this could again culminate into two paths, i.e. a tender offer or a proxy fight. Pre-takeover Defence Strategies Poison Pills: The poison pill is a legal device that makes it prohibitively costlier for an acquirer to take control of the target, without the prior approval of the target's board of directors. Most poison pills make the target company less attractive by creating rights that allow for issuance of shares of the target company at a substantial discount to market value. There are two types of such poison pills, flip-in pill and flip-over pill. In case of a flip-in pill, these rights remain inactive until a threshold limit is reached, say 10%. So, in case 10% of the shareholding for any investor is breached, these pills are activated and immediately allow the shareholders (except the acquirer) of the target company to purchase the shares of the target company at a substantial discount (say 50%). It is likely that all the existing shareholders exercise the right, and purchase these shares. Hence, the number of existing shares double and if it is a cash-for-share exchange, the number of shares that need to be compensated for by the acquirer doubles and if the acquisition price remains unchanged, the cash outlay for the acquirer would double and hence makes the transaction unattractive. In case of a flip-over pill, these allow rights to the shareholders of the target company to acquire shares of the acquirer (or the surviving combined firm) at a substantial discount which also makes the deal unattractive at the outset. Poison Puts: In case of poison puts, the bond-holders of the target company have the right to put the bonds back at the company at a pre specified redemption price. Hence, this provision also gets triggered by a hostile takeover attempt and what happens is that there is an immediate cash drain as these bonds have to be redeemed by the Company at a higher than par value price, typically. The effect of this poison put therefore is that an acquirer must be prepared to refinance the target's debt immediately after take over to cover the cash crunch and hence raises the cost of acquisition. Restricted Voting Rights: Some target companies adopt a mechanism that restricts the shareholders who have recently acquired a big chunk of shares or who have exceeded a threshold % of shareholding, from voting on these shares. Shareholders who exceed this trigger point are no longer able to exercise voting rights on these shares unless the board of the target company releases the constraint. Hence, the very possibility of taking the effort to acquire a controlling stake but not being able to vote on these shares serves as a dampener. Golden Parachutes: These are compensation arrangements between the senior management and the target company. These contracts allow the senior executives to receive hefty cash settlements, if they leave pursuant to a change in control, and this stretches to a number of years' salary which is an attractive exit option. One reason these persist is that the senior executives have little fear of job losses and prefer to stick on till they exercise the exit option and without these Golden Parachutes, the target company executives would have left for better offers quicker to secure their future. However, from an acquirer's perspective, the impact may not be much as compared to the overall takeover consideration. Post-takeover Defence Strategies Share Repurchase: After the takeover is initiated, a target may initiate a cash tender offer for its own outstanding shares. An effective repurchase offer has the potential to increase the cost for the takeover (takeover premium) as the acquirer will now have to alter its bid upwards for it to remain competitive. That itself could be a put off for the deal. Leveraged Buy Out: In case of a leveraged buyout, the management of the target can partner with a private equity firm that specialises in buyouts to put in some capital and the remaining purchase price comes through from borrowings and hence the term "leveraged". With the proceeds that come in, that is used to is used to buy all the shares of the target company. Hence, essentially what is done is the target company buys all its shares to convert in to a private limited company in the transaction, called Leveraged Buy Out (LBO). The stakes therefore in the target company now shift to the Private Equity Firm (may be 10%) and the balance 90% of the firm is financed by debt (Banks). Now, the Private Equity Firms enjoy the effects of financial leverage that can magnify the returns, the only catch is that there has to be a due diligence conducted prior to conclude that the target company has sufficient strength in the profit and cash forecasts to be able to cover the future debt payments. The management then is compensated basis the performance of the firm post the LBO is completed. This strategy therefore allows the target to defend against a hostile bid provided that the LBO provides to the target shareholders a price that is greater than the takeover price offer by the acquirer. Pac Man Defence: The target can defend itself by making a counter-offer to acquire the hostile bidder. This is a rarely used technique as it is unlikely that the smaller company (target) makes a bid for the larger company (acquirer). White Knight Defence: This is probably one of the best outcomes for the target shareholders. The way it works essentially is that the management or board of the target company to seek a third party to purchase the company in lieu of the hostile bidder. This third party is called the 'White Knight', as it is coming to the aid of the target. This technique is used by the target when the acquisition by the white knight sounds like a strategic fit as compared to the hostile bidder. Based on this strategic fit, the third party can also justify a higher price for the target than what the hostile bidder is offering. In such cases, the winners curse prevails, as often such negotiations are driven by a tendency for the winner to overpay to grab the deal and this competitive bidding ends up being extremely favourable for the target shareholders.