What is a Toehold Purchase?

Toehold purchases are usually defined as acquisitions of less than five percent of the outstanding stock of a given company. The toehold purchase serves to establish the acquiring company’s interest in the corporation. It is not uncommon for companies to acquire a toehold purchase in other corporations as a means of generating a steady flow of revenue in the form of investment income or dividends.

However, the toehold purchase may not be simply a means of diversifying investments and creating steady revenue streams. Corporate raiders often will make use of a series of toehold purchases to quickly acquire a sizable amount of controlling interest in a given company. In decades past, a series of low profile toehold purchase transactions would allow a raider to gain control of a company before any notice was taken. Fortunately, that is no longer the case.

Today, many countries have established regulations that require investors to file documents with a government agency when a cumulative percentage of outstanding stock in a given company is acquired. Often, there is also a requirement for the investor to provide a written statement to the company in question regarding the motives for acquiring a larger percentage of stock. This approach has made it more difficult for raiders to take over companies without the knowledge of the owners and officers of the target company.

In the United States, the Securities and Exchange Commission sets the guidelines for what is considered to be a toehold purchase and what is not. When purchases exceed five percent, the SEC requires the investor to file documents indicating the ultimate goals associated with the purchase. At the same time, this information is provided to the target company.

This procedure does not prevent any corporate takeover attempt. However, it does provide the target company with the opportunity to determine if a takeover is desirable, and to take steps to prevent the takeover from occurring if that is seen as the best course of action. By defining a toehold purchase as being less than five percent of outstanding stock, regulatory agencies essentially are ensuring that the playing field between target companies and corporate raiders is a level one, with both side having equal opportunity to emerge as the victor in the takeover bid.