A toe hold is a preliminary step enacted by an acquiring company during a takeover. It consists of the acquirer purchasing stock in the prospective target so as to itself be a stockholder, with the associated rights of being so in the target firm.
This is often seen as a hostile act and may be the pre-cursor to a hostile bid as discussed in our article “Hostile Takeovers and Merger Arbitrage – What All Traders Should Know“. Target firms are of wary of investors accumulating large positions in their firm. Even if the intention is not a full takeover, a toe hold may lead to some variation of shareholder activism. This potential disruption makes any toe hold positon worthy of attention by management and the board of directors.
Toe Hold and Hostile Bids
Naturally, hostile bids of this nature often see acquirers with large toe holds. The drawback of this approach is the disclosure that needs to be made to the SEC via a Schedule 13D when a holding exceeds 5%. This must be done within 10 days of the purchase. This publicly available information may dissuade the acquirer from accumulating a substantial position as the company will become fore warned of the impending action.
Friendly takeovers on the other hand avoid the need and cost of taking a toe hold position. Financing is often provided to purchase the target as a whole. By taking a toe hold, or buying the target firm piecemeal, the acquirer may be using its own cash resources. These may be better deployed elsewhere in the firm rather than undertaking the risk of embarking upon a hostile takeover strategy. Subsequently, should the deal not consummate as expected, the acquirer may be left holding a large positon in a company for which it no longer has a long term strategic interest. In addition, it is also likely the target stock would have been bought at ever increasing prices. Should the deal not succeed, the price will retreat leaving the buyer with a potentially sizable loss.
