Lobster Trap
What Is a Lobster Trap?
A lobster trap is a defense strategy utilized by small target firms to safeguard themselves against hostile takeovers initiated by larger corporations.
Companies that utilize this anti-takeover measure pass provisions in their charters that block shareholders with a stake of over 10% from converting securities into voting shares. This keeps large shareholders from adding to their voting stock position and facilitating the takeover of the target company.
How Lobster Traps Work
Hostile takeovers are common in the corporate world. They happen when one company attempts to assume control over another without getting the express endorsement or consent of the target association's board of directors (B of D). In these cases, the potential acquirer might initiate several strategies, for example, issuing an offer or buying the target's available stock to gain control.
Target firms have a number of strategies available to shield themselves against these unsolicited offers. One of these is the lobster trap.
In order to set a lobster trap, a company must have a provision outlining subtleties of the strategy in its charter. At the point when the expected target of a hostile takeover chooses to utilize a lobster trap as its defense, it enforces a rule in its charter that forestalls certain shareholders — the people who hold over 10% of converting securities — from converting their holdings into voting stock.
The convertible securities covered by the lobster trap provision include any assets that can be changed over into voting stock, including convertible bonds, convertible preferred shares, convertible debentures, and warrants.
Companies must have a provision in their charter in order to enforce the lobster trap.
Lobster traps are generally employed by small companies, specifically to catch and impede large hunters trying to take them over. It very well may be utilized either without help from anyone else or related to different strategies, for example, the poison pill, white knight, or scorched earth.
Illustration of a Lobster Trap
Say an enterprise named Small Pond gets a hostile takeover bid from larger rival Big Fish Inc.
Small Pond's directors and management are very averse to the company being gobbled up by Big Fish and try to scrounge up shareholder support to dismiss the offer. They are aware of a large hedge fund that possesses 15% of Small Pond's voting shares, that's what plus warrants, whenever changed over, would give it an extra 5% stake in the company.
Luckily, Small Pond's founders had the foreknowledge to include a lobster trap provision in their corporate charter to keep the company from falling into undesirable hands. The company's B of D proceeds to utilize the provision to forestall the hedge fund from converting its warrants into voting shares and prevails with regards to rejecting the hostile bid.
Lobster Trap versus Other Defense Strategies
As verified above, there are several strategies potential targets can use to protect themselves against hostile takeovers. Every one of them are intended to make the prey less appealing to a acquirer. They each work in various ways, however, with the specific method picked generally depending on the company's size and its charter.
Beside lobster traps, other anti-takeover measures commonly utilized in the corporate world include:
Poison Pill
Poison pills come in two forms: the flip-in and flip-over. The former, the more normal of the two, permits shareholders, with the exception of the acquirer, to purchase extra shares at a discount, consequently boosting their equity position while decreasing the acquirer's stake after it purchases shares in the company. The last option, then again, permits stockholders of the target to purchase the shares of the acquiring company at a profoundly discounted price on the off chance that the hostile takeover endeavor is fruitful.
A core aim of the poison pill is to force the acquirer to come to the negotiating table, as opposed to permit it to assume control over the target essentially.
White Knight
This strategy basically enables a friendly company — alluded to as a white knight — to assume control over a target and salvage it from the grasp of an unfriendly black knight.
On the off chance that a takeover is inevitable, most companies generally incline toward being acquired by a friendly company instead of a hostile one. That is on the grounds that the white knight ordinarily attempts to retain the integrity of the target's business as opposed to roll out sweeping improvements to it. The target's investors may likewise benefit from a better offer for their shares in a white knight scenario.
Scorched Earth
This approach makes the target look less alluring to the acquirer by spoiling its corporate scene. Companies that utilization the scorched earth policy may assume extra debt, sell off assets, and give their management groups large payouts on the off chance that they're supplanted with new executives.
The scorched earth strategy is widely seen as a last resort strategy and can frequently be dangerous. Companies will be unable to recuperate assuming they take on too much debt or on the other hand assuming they sell assets that are significant to their operations.
Features
- Shareholders with a stake of over 10% are blocked from converting securities into voting shares.
- The lobster trap is a strategy used to safeguard small companies against hostile takeovers initiated by larger corporations.
- Securities covered by the provision include convertible bonds, convertible preferred shares, convertible debentures, and warrants.
