he term poison pill refers to a defense strategy used by a target firm to prevent or discourage a

potential hostile takeover by an acquiring company. Potential targets use this tactic in order to
make them look less attractive to the potential acquirer. Although they're not always the first—
and best—way to defend a company, poison pills are generally very effective.

KEY TAKEAWAYS

 A poison pill is a defense tactic utilized by a target company to prevent or

discourage hostile takeover attempts.
 Poison pills allow existing shareholders the right to purchase additional shares at a
discount, effectively diluting the ownership interest of a new, hostile party. 
 Poison pills often come in two forms—the flip-in and flip-over strategies.
How Poison Pills Work
Takeovers are fairly common in the business world, where one company makes an offer to
assume control over another. Larger companies tend to take over smaller ones if they want to get
into a new market, when there are operational benefits by combining both entities, or when the
acquirer wants to eliminate the competition. Takeovers, though, aren't always harmonious and
become hostile when the target doesn't entertain or want to be taken over.

When a company becomes the target of a hostile takeover, it may use the poison pill strategy to
make itself less attractive to the potential acquirer. As the name indicates, a poison pill is
analogous to something that's difficult to swallow or accept. A company targeted for an
unwanted takeover may use a poison pill to make its shares unfavorable to the acquiring firm or
individual.

Poison pills also significantly raise the cost of acquisitions and create big disincentives to deter
such attempts completely.

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