A toehold purchase is an accumulation of less than 5% of a target firm’s outstanding stock by another company or individual investor with a particular goal in mind. If the toehold purchase is made by another company, it may be a precursor to an acquisition strategy, such as a takeover bid or tender offer.
If an individual investor makes the toehold purchase, they usually accompany their purchase with demands that the target company take steps to increase the shareholder value of the firm.
A company or investor can quietly amass a toehold purchase of a target company’s stock without notifying the target firm or having to file a Schedule 13D with the Securities and Exchange Commission (SEC).
A toehold purchase can be the precursor of a company’s attempt to acquire the target firm.
Activist investors use toehold purchases to pressure companies to meet certain demands, such as implementing changes that would increase shareholder value.
A toehold purchase by a company may be a signal that it is interested in eventually acquiring the target firm. This potential acquirer can quietly amass up to 5% for its toehold as it considers its strategic options. But if it crosses the 5% threshold, it must file a Schedule 13D with the Securities and Exchange Commission (SEC). It must also explain to the target firm in writing the reason for the purchase of 5% or more of its stock. Filing a Schedule 13D also notifies the public of what the company is intending to do with its toehold purchase.
A toehold purchase by an investor normally means they intend to shake up the target firm in certain ways in an attempt to boost the firm’s market value. This activist investor would announce to the company’s Board of Directors in a public letter that they have built up a material stake, outline their reasons for the investment, and suggest (or demand) specific actions to increase shareholder value. This notification to the public can, and often does, take place before the 5% mark is reached.
Establishing a toehold position is one tactic a company can adopt as it pursues an acquisition of a publicly traded company. If the acquiring company is planning a hostile takeover of a target company, establishing a toehold position allows it to begin purchasing shares of the target without being detected by the company’s management. The strategy enables the potential acquiring company to remain under the radar as long as possible while it positions itself in an attempt to take control of the target company.
Once the acquiring company is ready to make its takeover intentions public, it will often do so through a tender offer. The acquiring company will offer to buy shares from the target firm’s shareholders, usually at a price above the current market price. The acquiring company can bypass the need to get approval from the target firm’s board of directors by making its tender offer directly to the shareholders and offering them a premium price as an enticement to accept the offer. For this tactic to work, the acquiring company will usually need to gain the approval of a majority of the shareholders.
The Williams Act is a federal law that protects shareholders during hostile takeover attempts by ensuring acquiring companies disclose important facts, such as their financing source and plans for the company after the takeover completion.
Paul Singer of Elliott Management Corporation, a prominent activist investor, has had much success with the strategy of making toehold purchases, agitating for changes at his targeted investment, and then eventually cashing out at substantial profits if his recommendations or demands are implemented effectively.
In November 2016, Singer disclosed a 4% holding in Cognizant Technology Solutions along with his ideas for lifting profitability and returning cash to shareholders. He also insisted on change at the board of directors’ level. The results were swift. In February 2017, Cognizant agreed to replace three new independent directors and committed to plans to expand profit margins and return capital to shareholders.