Shark Repellent Tactics in Investment Banking

The profession of investment banking has evolved over the years. Earlier, they were only used when companies wanted to issue securities and raise capital. Over the years, companies have realized that investment bankers know how to make securities more palatable to the investor community. Hence, they also know how to run the process in reverse, i.e., how to make a company less attractive to a potential investor. Over the years, a wide variety of tactics have been developed by investment banks to ward off unwanted attention.

These tactics are called shark repellent tactics. This naming assumes that the company is the target of a shark, i.e., a predatory investor. Hence, it must use repellant techniques to avoid such a takeover. Hence, the tactics are known as shark repellent tactics. Some of these tactics have been explained below:

Shark Repellent Techniques

Companies can ward off potential attempts for hostile takeover by making the takeover too expensive for the acquiring party. Often, this is done by issuing securities that have different covenants. Each bond issued has to follow the terms and conditions laid down in the covenant. In many cases, covenants include terms that are favorable to the current management. However, they become unfavorable for the acquiring party. For instance, it is common for companies pursuing shark repellent tactics to sell bonds that have to be redeemed at 100% of the face value if the original management is in place. However, if a takeover takes place, then the acquiring investor will have to redeem the bonds at 150% of the value! Sometimes there are terms inserted in the contract, which make it compulsory for the acquirer to pay huge sums of money to the existing management if they are being laid off after an acquisition. This is called a golden parachute, and once again, this is used to repel the acquirer. This makes the acquisition target expensive and undesirable in the eyes of the acquirer.

Investment bankers also help companies use their equity shares strategically while trying to avoid a takeover. This strategy is commonly known as a poison pill. As a part of this strategy, investment bankers try to keep track of their clients’ shares being purchased by the acquirer. If they are afraid that the acquirer might be able to take a significant stake, the investment bankers get the client to issue more shares. These shares are sometimes sold at water down prices to other parties. The logic is to dilute the value of the stake, which is already owned by the acquirer. This makes the acquisition process expensive.

Investment bankers also advise their clients to issue preference shares as bonus shares to their investors. These bonus shares will only get an extra dividend for some time. However, at a cut-off date, they will either be extinguished or be converted into equity shares. This conversion into equity shares could be linked to a change in management. Hence, if there is a change in management, many preference shares will be converted to equity shares, and the stake held by the acquirer will be diluted. To avoid this, the acquirer would have to buy more shares during the acquisition process, making the process expensive and sometimes futile!

Investment bankers can also make the company unattractive by selling off the majority of its assets to friendly third party companies. These contracts will include a buy-back clause at a reasonable price if the management has not been changed. However, if the management has been changed, then the third party may have the right to refuse to sell back the assets at the agreed-upon price. This is called the "white knight" defense since it involves a favorable third party, i.e., a white knight.

It is common for investment bankers to strike a deal with the acquiring party as well. Often times, investment bankers strike a deal with the aggressive party. In such deals, the stake of the aggressive party is purchased by the target company at a significantly higher price. Hence, they make a part of the money that they were looking to make and move on to the next target.

Lastly, in some cases, the smaller company decides to turn the table on the larger company by acquiring it. This acquisition involves undertaking a lot of debt and is called a leveraged buyout. Here too, the investment bankers are the most trusted ally of their client.

The bottom line is that investment bankers have a wide variety of tactics that they can use in order to help clients fend off potential bidders. However, sometimes, this may not be in the best interest of the shareholding community. Investment bankers often collude with management and use these tactics to fend off acquisitions, which may be in the best interest of the shareholders. This is the reason why there is an ethical conundrum when shark repellent tactics are used.