What Is a ‘Poison Pill’ Defense?

On Friday, Twitter countered Elon Musk’s offer to buy the company for more than $43 billion with a corporate tool known as a poison pill, a defensive strategy familiar to boardrooms trying to fend off takeovers but less familiar to everyday investors.

This defense mechanism was developed in the 1980s as company leaders, facing corporate raiders and hostile acquisitions, tried to defend their businesses from being acquired by another enterprise, person or group.

What is a poison pill?

A poison pill is a maneuver that typically makes a company less palatable to a potential acquirer by making it more expensive for the acquirer to buy shares of the target company above a certain threshold.

“The whole point of it is to make the offer from the board more attractive than the acquirer,” said Carliss Chatman, an associate professor of law at Washington and Lee University.

The strategy also gives a company more time to evaluate an offer and can give the board leverage in trying to force a direct negotiation with the potential acquirer.

What does a poison pill actually look like?

A poison pill is officially known as a shareholder rights plan, and it can appear in a company’s charter or bylaws or exist as a contract among shareholders.

There are different types of poison pills, but usually, they allow certain shareholders to buy additional stock at a discounted price, said Ann Lipton, an associate professor of law at Tulane University.

The only shareholder blocked from making these discounted purchases is the one who triggers the poison pill. It is triggered when a person, usually the acquirer, hits a threshold for how many shares they own. If they hit that threshold, the value of their shares is suddenly diluted as other shareholders make discounted purchases.

Securities experts say that investors rarely try to break through a poison pill threshold, though there are exceptions.

The pizza chain Papa John’s adopted a poison pill in July 2018 in a rare instance of a company trying to block its founder from taking over. After using a racial slur on a conference call and setting off an uproar, the founder, John Schnatter, resigned as chairman of the company’s board that year, owning 30 percent of its stock at the time.

The poison pill would have allowed shareholders to buy stock at a discount if Mr. Schnatter, his family members or friends raised their stake in the company to 31 percent or if anyone else bought 15 percent of the stock without the board’s approval. The dispute ended with a settlement in March 2019.

In Twitter’s case, the pill would flood the market with new shares if Mr. Musk, or any other individual or group working together, bought 15 percent or more of Twitter’s shares. That would immediately dilute Mr. Musk’s stake and make it significantly more difficult to buy up a…