Company share buybacks
Sun 10 December 2023
Reasons for a share buyback
A share buyback is where a company repurchases its own shares from the shareholders. There are 3 main reasons private limited companies may think about repurchasing the company shares. In order of popularity these are :-
- Provide a tax efficient exit for shareholders - where a private company has a small number of shareholders and one of them wishes to exit, a buyback means remaining shareholders don't have to personally finance the exiting shareholder. Share buybacks can also be used to purchase shares issued to employees under incentive schemes when they leave the company.
- Return excess cash to shareholders - Private companies often accumulate excess cash as a result of successful operations or the sale of assets.
- Increase gearing (debt to equity ratio) - share buybacks can also raise gearing by increasing the proportion of debt relative to equity. This can be beneficial for companies seeking to expand their operations or invest in new projects.
Legal issues with company repurchase of shares
There are a number of legal considerations that must be taken into account when a private company repurchases its own shares. These include:
- Shareholder approval - A private company must obtain approval from its shareholders before it can repurchase its own shares. This is typically done by a special resolution.
- Capital maintenance - A private company must ensure that its capital is sufficient after a share buyback, so net assets should not be less than share capital.
- Tax implications - To qualify for tax benefits the selling shareholder needs to have owned the shares for at least 5 years, there needs to be a plausible business reason for the buyback and HMRC must be satisfied the buyback is not primarily to avoid tax.
Pricing and funding of share buyback
A buyback has to be funded from distributable reserves (post tax profits) and the price can be set at any amount as long as acceptable to the selling shareholders. If the buyback is not funded from distributable reserves, HMRC may refuse advantageous tax treatment.
There are some ways around the distributable reserves problem if a company does not have funds in the bank. Options include :-
- Issuing new shares to fund the buyback.
- A staged buyback – where payment for the shares is agreed as being due from future distributable reserves i.e future profits. There are obvious risks with this for the selling shareholder and protections such as a guarantee and other methods will generally be needed.
Key clauses in the Share buyback agreement
- Purpose of the Share Buyback - the agreement should clearly state the purpose of the share buyback.
- Scope and criteria - number of shares to be repurchased and agreed price.
- Funding Mechanism- the agreement should outline the funding mechanism for the share buyback, such as from existing cash reserves, new debt issuance, or a combination of both.
- Timing - the agreement should specify the time frame for the share buyback, such as a fixed period or an open-ended period.
- Approval Process - such as board approval or shareholder approval.
- Termination Options - such as if certain conditions are not met and other protections especially if payment is on a deferred basis
- Regulatory Compliance - to ensure compliance with all applicable UK laws and regulations governing share buybacks.