What it means
A hostile takeover happens when a buyer goes directly to a company's shareholders without the board's agreement. Boards that want to resist have several options, and the suicide pill is one of the most extreme.
The name reflects the logic: the company is prepared to damage itself to avoid being taken over. The target might borrow heavily to pay a large dividend or buy back shares, sell its best division, which is often called the crown jewels, or agree to terms that would be costly if control changed.
A suicide pill is different from a poison pill, which is a shareholder rights plan that makes a takeover expensive for the bidder, usually by letting other shareholders buy shares at a discount. The poison pill is aimed at the buyer, while the suicide pill hurts the company itself.
Directors have a legal duty to act in the best interests of the company and its shareholders, so an extreme defence can be challenged in court. If the board's real aim is to protect its own jobs rather than the owners' value, the move can lead to lawsuits and damaged trust.
The cost shows up in the numbers. More debt means higher interest payments and less room to invest, a lower credit rating and tighter loan terms, while selling a core business shrinks future earnings.
Investors usually mark down the share price of a company that takes such steps unless the benefit is clear. Most companies today prefer milder defences, such as staggered boards, rights plans or finding a friendlier buyer.
For managers and investors, the term is a warning that a defence can cost more than the takeover it prevents.
In practice
Real-world examples.
Example
A manufacturer facing a hostile bid borrows heavily to buy back its own shares. The additional debt makes it less appealing to the bidder, but it also makes the business riskier for the owners who remain. The board must then keep up the interest payments through any downturn.
Example
A media group sells its most profitable channel as soon as a hostile offer is announced. The sale removes the asset the bidder wanted, but it also reduces the group's earnings. Analysts cut their forecasts, and the share price drops further than the bid had suggested.
Example
A board discusses a suicide pill but rejects it after its advisers explain the likely damage to the share price and the legal risk. It chooses to seek a rival offer instead. The directors record their reasoning in the minutes in case they are later questioned.
Formula
Calculation
Debt to EBITDA = Total debt / EBITDA (earnings before interest, tax, depreciation and amortisation)
A target company has EBITDA of $50,000,000 and debt of $100,000,000, so its ratio is $100,000,000 / $50,000,000 = 2.0 times. To fend off a bidder, it borrows another $250,000,000 and uses the money to pay a special dividend. Debt rises to $350,000,000, and the ratio becomes $350,000,000 / $50,000,000 = 7.0 times, a level that many lenders regard as dangerous and that makes the company a less attractive target.Case study
Seen in the real world.
Atlas Packaging is an illustrative, fictional company that received an unsolicited offer from a larger rival at $30 a share. The board believed the offer was too low and feared losing its independence.
The directors considered borrowing $400,000,000 to pay shareholders a special dividend. With EBITDA of $100,000,000, that would have raised debt from $200,000,000, which is 2 times EBITDA, to $600,000,000, which is 6 times. Their advisers warned that the company might struggle to meet interest payments if sales dipped.
In this illustrative story, the board rejected the idea and instead negotiated with a second bidder, eventually agreeing a sale at $36 a share. Shareholders received more value than under either the original offer or the suicide pill, and the company avoided a risky level of debt. The board later reported that the first hostile offer had made it more careful about how it communicated with investors.
Watch out
Common mistakes.
- Confusing a suicide pill with a poison pill, when the first harms the target and the second burdens the bidder.
- Assuming a defence that stops a takeover is good for shareholders, when it may reduce the value of their shares.
- Ignoring the duties of directors, which can make an extreme defence legally risky.
Questions
People also ask.
Is a suicide pill legal?
It depends on the jurisdiction and the facts, and courts may examine whether the board acted in shareholders' interests.
Why would a board use one?
It may believe the company is worth more independent or that the bid undervalues the business, although the cost can be high.
What are alternatives?
Boards can seek a rival bidder, negotiate a higher price, adopt a rights plan or persuade shareholders to reject the offer.
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