What are share buybacks?
A share buyback is when a company purchases shares it has previously issued. The primary reason for doing so is to return cash to its shareholders, including on the exit of a shareholder due to their death or departure for example.
The Companies Act 2006 outlines the procedure that must be followed in order for a company to perform a share buyback. These rules are simpler than those relevant under the previous legislation.
Shareholder Agreement
A share buyback must be authorised by a contract that is approved by shareholders holding at least 75% of the voting rights in the company. Providing no shares are actually purchased prior to approval, the contract itself can be entered into before or after it is approved, and may be conditional on certain events, such as the shareholder whose shares are to be bought back, leaving the company.
How can the buyback be funded?
The company can buy its own shares only if it has the funds available to do so. It can use money produced by profits, in which case reserves of profit are allocated to a capital redemption reserve to replace shares bought back; or the company can use the proceeds of a fresh issue of shares, the fresh issue being used to replace the shares bought back.
As a last resort, a private company can use some of its capital, but various additional conditions must be satisfied in order for the company to be able to use its capital in this way.
When and why would a company buyback shares?
Share buybacks are a useful method by which to return cash to shareholders when a company has surplus cash, perhaps as a result of the disposal of a business or significant asset or where cash was raised to fund a project or acquisition that subsequently fell through.
Other reasons for a company to perform a share buyback would be:
- to increase the company’s leverage (the ratio of debt to equity) to ensure an increased return for shareholders, and/or to make the company a more attractive investment prospect. It is important however that the buyback will not put the company in breach of any financing agreements;
- to buy out a retiring or disgruntled shareholder where the other shareholders are not able or willing to purchase their shares. This is usually a preferable option for the remaining shareholders, as opposed to a third party buying out the exiting shareholder. A purchase of the relevant shares by the company could also be the most tax efficient method of buying out the shareholder; or
- The redemption of any redeemable shares that the company has issued.
The Legal Requirements of a share buyback
Beyond the approval of shareholders, a number of procedures and filing requirements must be adhered to when a company purchases its own shares, and these are laid out in the Companies Act 2006. A company with only one shareholder needs to be especially vigilant that it complies with all requirements when approving the buyback contract.
Any shares purchased must be paid for in cash at the time of purchase and the shares bought back are usually cancelled.
Stamp duty is payable on the transfer of shares to the company if the consideration exceeds the relevant threshold (In 2011 this is £1,000.00).
A copy of the share buyback contract must be kept available for inspection by shareholders for a period of 10 years beginning with the date of purchase.
The accounts for the period in which the shares were bought back must include appropriate disclosures relating to the buyback.
Share buybacks funded through capital – additional procedure for private companies
In order to protect the interests of the company’s creditors, there are additional requirements when using capital to fund the buyback of shares.
Shareholders with at least 75% of the voting rights in the company must approve the use of capital to fund the purchase, with further rules on which shareholders can vote, how the proposed use of capital is advertised to the shareholders and creditors of the company, and when the purchase using capital can proceed. There are also further filing requirements.
The company directors must make a statement regarding the company’s solvency in a prescribed form. The auditors of the company must support that statement with an additional report. There are also additional requirements with regards to how the statement and report must be circulated to shareholders.
Any creditor disapproving the use of capital can apply to court to block the use of capital to buy back the shares.
Restrictions on a share buy back
- There must be at least one non-redeemable share left in issue after the buyback
- The shares to be purchased must be fully paid up
- Most importantly, the company’s Articles of Association must not restrict or prevent a share buyback.
Conclusion
Private companies with existing capital redemption reserves will find the process of share buybacks relatively straight forward. Using capital to fund a share buyback is notably more complex and open to challenge than through the use of company profits. Whilst share buybacks are an important means of returning cash to shareholders in a number of circumstances, readers might also want to consider whether a reduction in share capital might be more suitable.
Jamie Hunt
LegalClarity.co.uk
The information provided in this article is intended as a general guide only. It is not exhaustive or tailored to your individual circumstances. In particular this article does not intend to cover the purchase of treasury shares or an ‘on market’ buyback by a public company of shares listed on a recognised exchange.
