Lobster Trap
A defensive strategy implemented by targeted companies to avoid hostile acquisition by more giant corporations for their profit-centric corporate interests.
What Is A Lobster Trap?
The Lobster Trap is a defensive strategy implemented by targeted companies to avoid hostile acquisition by more giant corporations for their profit-centric corporate interests. But why the name Lobster Trap?
The strategy of the Lobster Trap allows targeted companies to trap hostile companies by enticing hostile acquirers. They could convert shares into voting rights to assert dominance when, in reality, the targeted companies have restrictive charters limiting the share conversion.
“Why would a corporate giant want to acquire in a hostile manner? Is it even legal to do so?”
The corporate world tends to be a very volatile place. We know it is where financial growth is, but in terms of the company's point of view, it is a very competitive and unforgiving place, even just to survive, let alone financial growth.
Mergers & acquisitions are common sights in the corporate world, and there is a growing need for professionals and consulting firms with expertise and knowledge in the field, showing how lucrative such events are.
These events need not be friendly at all, and the most interesting part is that they are completely legal. To prevent such hostility from large corporations, small to medium-sized companies implement strategies to safeguard themselves from such predatory tactics.
Key Takeaways
- The Lobster Trap is a defensive tactic used by targeted companies to prevent hostile takeovers by incorporating restrictions in the company’s charter limiting the conversion of shares into voting rights.
- The corporate world is unforgiving, and acquisitions are common, even hostile ones. Such hostile acquirers target the target company's shares to attain voting rights to gain control, finalizing the acquisition.
- Other defensive strategies include White Knight, Poison Pill, and Scorched Earth.
- Scorched Earth is a last-resort tactic with potential drawbacks if unsuccessful.
- White Knight involves a friendly company saving the target company from a hostile takeover.
- Poison Pill offers options to affect the acquirer's stake power and equity.
Understanding A Lobster Trap
As mentioned before, the Lobster Trap is a defensive strategy implemented by a targeted company vulnerable to acquisitions, typically small firms, to prevent hostile takeovers from large corporations in the market.
When a prosperous small firm decides to expand its business operations, one of the options for growth is to go public. Going public has pros and cons, but discussing them is beyond the scope of this article.
In a nutshell, small firms decide to go public to obtain additional funding for business expansion from the public in exchange for getting exposed to the preyful eyes of large corporations in the market.
“But how can a company take control of other companies without consent, and that too legally?” Even though it can sound unethical, considering how such large corporations consume smaller companies, it is done for the ultimate financial gain and business expansion in the market.
Such feats are made possible using the rights reserved for shareholders of the company.
Shareholders are individuals who hold shares in a company, representing partial ownership and giving them certain rights, including voting rights. The more shares are acquired, the more power they have in the company’s decision-making via vote.
This is exactly what large companies target: voting rights. To prevent such hostile takeovers, there exist legal options that a small company can indulge in to prevent such unfavorable takeovers.
To attain protection from such non-consensual acquisitions, companies implement anti-takeover measures such as the Lobster Trap, in which the companies set a limiting provision of 10% in their charter that stops the conversion of convertible securities into voting power.
This way, the large corporation cannot have any voting rights to make decisions for the company with an agenda, therefore safeguarding the small firms legally from such hostile takeover from larger companies.
Note
Convertible securities are those securities that have the capability to convert into an equity security, such as common stock, to attain voting rights.
These convertible assets are convertible bonds, preference shares, debentures, and warrants.
Lobster Trap vs. Other Defensive Strategies
The legal defensive measures are not just limited to the Lobster Trap; rather, there are provisions available for small firms to indulge in to safeguard their vision from the greed of large corporations. Not everyone is ready to forgo a billion-dollar idea for a million-dollar peanut.
As mentioned before, the corporate world is an unforgiving place to be, and to survive, one must be prepared. All these defensive tactics are implemented to make the acquirer feel less attracted to the acquiree.
The available tactics are implemented by different firms based on the purpose, approach, size of the entity, and the types of the entity’s charters. Some common tactics are:
- White Knight
- Poison Pill
- Scorched Earth
White Knight
The White Knight strategy is a defensive strategy where the target company approaches a friendly company to acquire the shares to prevent the hostile company from acquiring the target company.
This strategy is more of a friendship type of measure built upon trust. The friendly company (referred to as the White Knight) comes to save the target company as a Knight in Shining Armor from the hostile company (Black Knight).
This approach is taken during desperate moments when hostile acquisition is inevitable. As they say, desperate times call for desperate measures.
Acquisition by a friendly company is much better than a hostile one due to the trust in White Knight in keeping the target company’s integrity. You might as well add that aside from roses and butterflies, the target company's shareholders would get better prices for their shares.
There is no love in the corporate world; it's all about money, influence, and power. And anyone who says otherwise is living a life of ignorance. Ignorance is not bliss when there is something of high value at stake.
Poison Pill
The Poison Pill is a defensive tactic the target companies use to bring the bidder into a negotiation. The main objective of this tactic is to come on favorable terms instead of being acquired in a hostile manner where the beneficiary is the acquirer.
The situation is just like in the Matrix movie, where Morpheus offers Neo two pills - Blue to forget and Red to regret. Similarly, the target company offers the acquirer two pills: To flip-in or to flip-out.
The common pill offered would be the flip-in, where the existing shareholders (except the acquirer) are offered additional shares at the discounted rate, which would decrease the stake power of the acquirer and additionally increase the equity of the target company.
The next pill would be flip-out, where the acquirer is successful at the takeover, but the target company's shareholders are offered shares of the acquiring company at massive discount rates.
Scorched Earth
Scorched Earth is another defensive tactical policy implemented by small companies to ward off hostile acquisitions from larger companies. This tactic creates an unfavorable economic condition that discourages the acquirer from pursuing the acquisition.
Companies indulging in the Scorched Earth policy engage in value-diminishing activities such as selling assets (especially the Cap Ex), providing fat payouts to the old management, taking unwanted heavy debts, and such to make the acquirer's investment unfruitful.
Note
The idea of the Scorched Earth policy was derived from the historical military tactic of Scorched Earth, where the army burns everything on the land, including livestock and farms, to stop the invading forces' advancement.
For instance, during the Second Sino-Japanese War, retreating Chinese troops burned cities to stop the advancement of the invading Japanese army.
Scorched Earth measures should only be considered as a Last Resort where you don't have a limiting charter (Lobster Trap) or a knight in shining armor (White Knight) to save your company from the acquirer. If the measure backfires, it's worse than being forcibly acquired.
Understanding Lobster Trap Application Using An Example
To understand how a Lobster Trap is applied practically, let's look at a relevant example.
Lineage Company is a small tech start-up specializing in advanced AI modeling. For the first stage, Lineage Co has found a couple of investors to hold the market, and the visionary expertise of Lineage Co has upheld its name in the market.
Lineage Co has a vision to expand further and reach globally. Therefore, it decided to go public by issuing its IPO. This announcement pleased the public as they trusted Lineage’s growth.
Armech Corporation is a large tech company that has dominated the market for quite a long time. Armech has been intrigued by Lineage Co for its revolutionary AI modeling and believes Lineage’s revolution can further take Amrech to great heights.
Armech had offered a deal that the Lineage Board of Directors decided to decline. Armech, being the ruthless one it is, decided to buy up the shares of the Lineage Co to attain the voting rights to shift the decision dynamics in Armech’s favor.
But to Armech’s disappointment, the investment made was not fruitful due to the measure of Lobster Trap implemented by the Lineage Co, who had anticipated such hostile takeovers from larger corporations from the inception.
The investment of Armech has exceeded 10% and was unable to convert to voting rights due to the charter restriction by the Lobster Trap, allowing the target company to avoid the hostile bid of the acquirer.
Lobster Trap FAQs
A Lobster Trap is an anti-takeover measure implemented by the target companies to avoid a hostile takeover by implementing a limiting factor in its charter, which would hinder the conversion power to voting rights if the shareholder exceeds the 10% limit on holding the shares.
A White Knight measure is an anti-takeover measure implemented by the target company to avoid a hostile takeover by allowing a friendly allied company to take over the target company before the hostile company could, therefore keeping the integrity of the target company intact.
A Poison Pill is an anti-takeover measure implemented by the target company to avoid a hostile takeover by pressurizing the acquirer into a negotiation by offering two pills - flip-in and flip-out, which benefits the target company instead of a complete takeover benefiting the acquirer alone.
A Scorched Earth measure is an anti-takeover measure implemented by the target company to avoid a hostile takeover by creating an unfavorable economic situation within the company to ward off the acquirer, such as taking unwanted heavy debts and selling assets.
Yes, anti-takeover measures are perfectly legal, and so is the hostile acquisition. Such anti-takeover measures exist legally to give a fighting ground for the target companies, who are vulnerable during the event of an unfavorable acquisition.
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