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What are poison pill provisions?

When control over a business changes hands, there is the potential for considerable disruption. Employees may be worried about their jobs; partners may worry about existing agreements; customers and clients might not like the change and stop supporting the business.

In other words, businesses leaders often have a lot riding on potential acquisitions and changes of ownership. In some cases, a company's board of directors may take steps to prevent such situations by adopting a so-called poison pill provision.

What is a poison pill provision?

A poison pill provision is a way to prevent an unwanted party from taking over a business. There are a couple ways to do this. 

In a flip-in situation, the board of directors may decide that should a party acquire a certain percentage of the company, they will discount share prices for all shareholders except the unwanted party. This dilutes ownership and makes it more expensive for the bidder to acquire ownership.

A flip-over option discounts the acquiring party's shares should that party take control of the company. Stockholders can then purchase the discounted shares. This also dilutes an undesirable party's stake in the company. 

Real-world example

Recently, the board of directors for Papa John's approved a poison pill provision in an effort to prevent John Schnatter -- the founder, former CEO and former chairman of the board -- from acquiring control of the company. 

The provision would go into effect if Schnatter gains more than 30 percent of the stock, which he and his associates currently own. If that increases, the company will offer discounted shares to shareholders. The same will happen if an outside party acquires more than 15 percent of the stock without board approval.

For companies facing similar situations

These types of solutions are controversial, and they are not right for every company. Because of this, it is crucial for business leaders to consult an attorney regarding ownership, acquisition and shareholder matters. Legal guidance allows business owners and entities to focus on the company and avoid missteps that further complicate a thorny issue.

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