How does a toehold purchase work?
What is a toehold purchase? It is a situation where a person or a company accumulates not more than five percent of a target company’s outstanding stock. People or companies do this because they often have a goal. Companies resort to this when their main goal is to acquire the target company in the long run, and the toehold purchase is just the start. It may also be for a takeover bid or a tender offer.
On the other hand, individual investors may also do this together with demand. They may want the target company to act and increase the firm’s shareholder value. There are different reasons, but as we mentioned, there is usually already a reason why they resort to this kind of purchase.
Companies and toehold purchases
A company that makes a toehold purchase from a target company is like a signal that they may be interested in buying or acquiring in the future. The acquiring company may silently buy 5% of the target firm’s outstanding shares while thinking about all the advantages and disadvantages that they will have upon acquisition. Buying more than 5% is a more tedious and lengthy process because there will be a need to file a Schedule 13D with the SEC. There should also be an explanation of why they would buy that amount of shares. A 13D Schedule is like telling everyone your intentions with the toehold purchase.
Individual investors and toehold purchases
We mentioned this earlier but let us explain it further. Individual investors also have the power to make a toehold purchase. They plan to make the target firm act so that its market value will increase. If that particular investor is an activist, he can also announce the board of directors through a public letter. This letter may contain that they already collected material stakes, highlighted investment reasons, made suggestions and demands regarding shareholder value increase, and the like. This public announcement usually goes before meeting that 5%.
What else should we know?
A toehold position is one of the many strategies that one company can do before fully acquiring the target firm. It is like passing through the gate of a hostile takeover without the management even noticing it. An acquiring company that makes a toehold purchase stays on the radar while it gets ready for taking over the whole company. With that being said, it can use a tender offer once it finally feels like it is already prepared to let everyone know its takeover intentions. The proposal to the target company’s shareholders is usually higher than what is stated in the current market price.
But what about the board of directors? They are called the board for a reason because they have the power to make important decisions about the company. If that’s the case, then why would an acquiring company offer the tender offer to the shareholders? There are many reasons for that, and one includes the rejection of the board. Hence, it directly makes an offer to the shareholders, and they give out a premium price that is hard to refuse. This tactic will only be successful if the majority of the shareholders agree.