Question

Suppose that you are a consultant that gives advice to small entrepreneurial firms that want to become corporations. As you know, becoming incorporated and publicly-traded (issuing common stock) involves adopting Articles of Incorporation, which establish the corporation’s Board of Directors structure, the number of authorized and issued shares, voting procedures, etc.

Today, a client walks in your office and explains that she has successfully operated a small restaurant for many years and is ready to expand. Therefore, she wishes to incorporate and raise enough common equity to open new locations all over Texas.

The client, however, is concerned about other firms trying to acquire control of her firm in the future and asks your advice about 1) what voting rules, if put in the articles of incorporation, might discourage a takeover, 2) whether the number of directors and the timing of their re-election is an important consideration, and 3) if there are any other ideas you might have to help her fend off possible take-over attempts. Give her some advice.

Answer 1

(1): Articles of incorporation should have voting rights plans. This plan separates certain shareholders in a company from their full voting powers at a predetermined point. For example suppose that shareholders of a company who owns 20% of that company will be, through the voting rights plans, not allowed to vote on issues like acceptance of a takeover bid or its rejection.

The article of incorporation can also have another voting rule which is called super-majority voting. On issues like mergers and takeovers 80% of the shareholders will have to approve of the deal rather than the usual 51% majority.

(2): Yes, the number of directors and timing of their re-election is also an important consideration. Optimally the number of directors should be between 8 to 12 so as to ensure that a faction of the board does not get biased and support a takeover. With regards to timing of their re-election the board members should be elected in a timely manner so as to ensure that issues like conflicts of interest, ethics, accountability, transparency etc. are taken care of.

(3): Other ideas that might help her fend off possible takeover attempts are strategies popularly known as ‘poison pill’ and ‘shark repellent’. Poison pill plan is centered on the shareholder’s rights plan. Shareholder’s right plan is issued in the form of a warrant or as an option that is attached to the existing shares. Implementing a poison pill increases the valuation of the company and hence discourages takeovers. Shark repellent refers to measures taken by a company to ward off a hostile takeover or an unwanted takeover. Tactics under shark repellent strategies are selling off assets, increasing debt levels, etc. All these activities make the target company less attractive to the company pursuing the takeover.