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Is a share buyback right for your company?

What is a Share Buyback?

A share buyback, also known as a share repurchase, is when a company purchases its own shares and returns the value of those shares to the selling shareholder.  Effectively a share buyback is where a company invests in itself and decreases the number of shares in issue.

Why might a company pursue a Share Buyback?

Improved Shareholder Value

Profitable businesses can assess the financial performance of their shares in a number ways including using the earnings per share (EPS) calculation. The EPS is a measure of profitability and is determined by dividing the company’s net profit  by the number of issued shares.

When a company carries out a share buyback, it reduces the number of issued shares. Assuming the net profit of the company remains the same, the EPS would increase and so would the price of the shares. This benefits the continuing shareholders of the company because they will now hold a greater percentage of the company’s shares at a greater value per share.   If a company believes its shares are undervalued, it may repurchase them to reward its investors.

Return surplus cash

Returning excess funds to shareholders is one of the key justifications for a company buying its own shares.  A company may have extra cash due to exceptional profitability, the sale of the business, or having funds available from an acquisition that has fallen through.  Shareholders will likely want the extra money given back to them because it is insufficient for a company to have surplus cash without a planned use.

Provide an exit route for shareholders

A share buyback can be used to facilitate the exit of a shareholder from a company.  If a shareholder wishes to exit the company, the company may buy the selling shareholder’s shares.  This prevents a third party from acquiring a stake in the business and avoids the need for the remaining shareholders from having to purchase  the departing shareholder’s shares themselves.

If an employee shareholder ceases to be employed by the company, a share buyback can be used to purchase shares issued to that employee under an employee incentive scheme.

Tax Benefits

A share buyback can bring tax benefits to the continuing shareholders.  This is because dividends paid to continuing shareholders are subject to income tax, however, the increases seen in the share prices would typically be classed as capitals gains.  Therefore, if the continuing shareholders sell their shares back to the company, the shares will be subject to capital gains tax rather than income tax.

If the continuing shareholders sell their shares back to the company, the shares will be subject to capital gains tax rather than income tax.

How does it work?

There are different procedures for share buybacks depending on whether it is a private or public company. This article will focus on private limited companies that repurchase their own shares.

Key requirements

If you are thinking about conducting a share buyback, it is important to seek legal advice.  This is due to the fact that the transaction might be void if you do not adhere to specific rules.

A limited company that buys back its shares must fully abide by the relevant rules .  These provide that:

  1. shares must be repurchased either off-market or on-market;
  2. approval is required from the shareholders;
  3. the shares being repurchased must be fully paid;
  4. at the moment of purchase, cash must be used as consideration for the buyback;
  5. the money for the buyback must come from distributable reserves, the proceeds of a new share issue, or capital in the case of a private limited business alone;
  6. after the purchase, the shares must be cancelled or if financed out of distributable reserves can be held in treasury.

In addition to the key requirements above, a share buyback necessities the preparation and filing of specific documentation.  For more information this, please feel free to get in touch with a member of the corporate team.

Situations that could render a share buyback invalid

Where a company buys back shares in breach of the rules, the buyback is void and unlawful.  Both the business and each of its officers that are found guilty of breaching the rules could have committed an offence.  A defaulting officer could receive a prison sentence of up to two years and an unlimited fine, or both.

Below are examples of where a court has found a share buyback to be void :

  • the share buyback was not expressly authorised by the company’s articles of association (Re RW Peak (Kings Lynn) Ltd [1998])
  • the business lacked enough distributable reserves to pay for the buyback (BDG Roof-Bond Ltd v Douglas and others [2000])
  • the purchase price had been left outstanding on loan account (Dickinson v NAL Realisations (Staffordshire) Ltd);
  • the purchase price was to be paid after completion (Kinlan and another v Crimmin and another [2006])
  • the purchase price was paid in instalments (Pena v Dale [2003])

Summary

A share buyback can seemingly be a simple transaction but is in fact governed by a complex set of rules and can easily go wrong.  .  Our team of corporate lawyers are experts at advising on and carrying out share buy backs. .

Please get in touch with our corporate legal team if you would like additional details about share buybacks.

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Disclaimer
This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full General Notices on our website.

About this article

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