Understanding Bear Hugs
A bear hug refers to a situation where a potential buyer attempts a hostile takeover of a company by offering a significantly higher price than the target company’s actual worth.
The strategy behind a bear hug is to apply pressure on the company to accept the proposal, with the risk of losing the board’s confidence.
The term “bear hug” symbolizes embracing someone tightly, leaving them with little room to escape.
In the context of acquisitions, it involves making a generous offer without seeking permission from the company’s board.
Leveraging Shareholder Pressure to Facilitate Acquisitions
A bear hug strategy aims to attract shareholders by offering an increased share value.
The shareholders, in turn, exert pressure on the company’s board to accept the deal.
The target company’s management has a fiduciary responsibility to generate the highest return for shareholders, which means shareholders can legally sue the company if it rejects the acquisition offer.
Bear hugs typically occur when a company is struggling, and its stock value has declined.
They also indicate resistance from the current management and board members toward a friendly deal.
While bear hugs often result in an acquisition, they come at a higher cost for the acquirer compared to a typical deal.
The new owners usually replace the existing management after a successful deal.
Consequences of Rejecting a Bear Hug
The company’s board can reject bear hug offers for legal and managerial reasons, but they are often bound to accept them in the interest of shareholders.
Here are two consequences of rejecting a bear hug:
- Lawsuit Against Management: If most shareholders believe declining the bear hug offer is not in their best interest, they can file a lawsuit against the management. In such a scenario, the management must justify how rejecting the offer benefits the shareholders.
- Direct Offer to Shareholders by the Bear Hugger: In addition to legal action, a bear hug acquirer may bypass the board and directly present the offer to shareholders. The acquirer offers to purchase the company at a value above the market price, allowing shareholders to sell their shares at a higher value than the market price.
Drawbacks of Bear Hugs
While a bear hug may appear to be an ideal option for an acquirer, it has drawbacks.
Bear hugs can be costly, and if the acquired product fails to perform well in the market, the acquirer may incur significant losses.
To convince shareholders, the premium offered is often much higher than the company’s actual worth, resulting in no value creation for the buyer.
Furthermore, bear hugs often lead to a complete replacement of the target company’s management, making them unfavorable for the executive team.
Additionally, bear hugs tend to be contentious and may involve lawsuits.
Even after closing the deal, the board may remain uncooperative with the acquirer.