What is Blank Check Preferred Stock?
Blank check preferred stock means special shares a company can give out whenever it wants to stop someone else from taking over the company. The company’s board of directors gets to decide when to do this on their own.
How Blank Check Preferred Stock Works
When a company gives out these special preferred shares, two things happen that make it harder to take over the company:
- The company has to pay money to the people who own these shares. This is called dividends. Dividends take money away from the company’s earnings.
- The company gets extra cash from selling these shares. It can use this cash to fight off the takeover.
Why Companies Use Blank Check Preferred Stock
A company might use blank check preferred stock if another company is trying to buy it out when it doesn’t want to be bought. This is called a hostile takeover. The company giving out the preferred shares is the “target” of the takeover.
The company trying to buy the target is called the “acquirer.” The acquirer wants to get enough shares of the target company to control it. But if the target company gives out a bunch of new preferred shares, the acquirer can’t get control as easily.
How Blank Check Preferred Stock Deters Hostile Takeovers
There are two main ways blank check preferred stock makes hostile takeovers harder:
1. Diluting Earnings
The dividends from the preferred shares cut into the target company’s profits. This makes the target less attractive to the acquirer.
Let’s say the target company normally earns $100 million a year. It gives out preferred shares that will pay $20 million in dividends each year. Now, the target company will only earn $80 million a year instead of $100 million.
The acquirer might not want the target company as much if it’s earning less money. The more shares the target gives out, the less attractive it looks.
2. Providing Cash for Defenses
Selling the preferred shares brings in a lot of money the target company can use to stop the takeover. The target might use this money to:
- Buy back its own shares so the acquirer can’t get them
- Pay for lawyers and bankers to help fend off the acquirer
- Buy shares of the acquirer to fight back
- Make itself look less appealing by taking on debt or selling important assets
The more cash the target company raises through preferred shares, the stronger its takeover defenses can be. This also makes the takeover more costly and difficult for the acquirer.
When Companies Decide to Use Blank Check Preferred Stock
A company’s board of directors gets to issue blank check preferred stock whenever it wants. The board doesn’t need approval from shareholders.
This lets the board react quickly to surprise takeover attempts. The board can give out the shares as soon as it senses a threat.
The board will decide how many preferred shares to issue and what their terms will be. The board sets the dividend rate and other rules for each batch of shares it gives out.
Downsides of Using Blank Check Preferred Stock
Issuing blank check preferred stock can have some drawbacks for the target company:
Upsetting Shareholders
Shareholders might not like the company giving out a bunch of new shares. The shareholders’ own shares will become a smaller piece of the company.
The shareholders also won’t get to have a say in the decision. They might feel like the board is making big changes without their input.
Scaring off Friendly Buyers
Using blank check preferred stock might scare off buyers who weren’t trying a hostile takeover. A friendly company that wanted to team up through a merger might back off.
The friendly company might not want to deal with the hassle and cost of the preferred shares. It might worry the target company will be less profitable or too difficult to negotiate with.
Spending a Lot of Money
Giving out preferred shares means paying a lot in dividends each year. The target company has to keep paying even if it’s having a bad year.
Meanwhile, the target might have spent the cash from the shares on defensive moves that don’t help the actual business. It may have taken on debt that’s now harder to pay off because of the dividend costs.
The target company could end up in a weaker financial position overall. This might not matter if it stops the hostile takeover. But if the takeover happens anyway, the company could be worse off than if it never issued the shares.
