Company share buyback overview

A private company share buyback involves the company repurchasing its own shares from existing shareholders, generally (although not always) reducing the total number of shares outstanding.

Companies typically implement buybacks for strategic reasons including :-

• returning excess cash to shareholders in a more tax-efficient way than dividends

• where a shareholder wants to exit but no other shareholders can afford to buy them out

• a dispute needs resolving through a forced share sale

• family succession requires redistributing ownership.

• to provide for death of a shareholder or divorce in a small private company - without a buyback, shares may pass to heirs who have no involvement, experience or interest in the company, potentially leading to management disruption or disputes. It’s important to ensure the company’s Articles of Association and any Shareholders’ Agreement allow and provide a process for share buybacks in the event of death.

Careful planning is essential as buybacks involve complex tax considerations for both company and selling shareholders. Common pitfalls include inadequate distributable reserves, improper valuations, and failing to follow strict Companies Act procedures, any of which can invalidate the buyback or trigger unexpected tax liabilities.

Share buyback rules

The Companies Act 2006 establishes strict conditions for share buybacks, balancing corporate flexibility with creditor and shareholder protection and requiring that :-

• Buybacks must be permitted by the company's articles of association.

• Shares must be fully paid.

• Payment must come from distributable profits or proceeds of a fresh share issue.

• Shareholder approval is required (typically by ordinary resolution).

• Contract for purchase must be available for inspection.

• Bought back shares must be cancelled or held in treasury.

• Strict filing requirements with Companies House.

Key considerations and pitfalls

• Effect on company's capital structure - consider impact on debt/equity ratio and future financing options

• Impact on remaining shareholders - changes to voting rights, dividend expectations and overall shareholding percentages

• Tax implications for company and selling shareholders - different tax treatment applies to company purchase versus third party sale, affecting both parties' tax position

• Cash flow requirements and timing - company must have sufficient liquid funds while maintaining working capital needs

• Valuation methodology - agreed basis for share valuation must be clear and justifiable, especially with minority shareholders

• Payment timing and structure - can be immediate or deferred, but terms must be approved by shareholders

• Inadequate documentation - full paper trail is essential including resolutions, solvency statements and statutory filings

How can a buyback be funded?

While the default position requires a buyback of own shares to be funded from distributable profits, several alternative funding methods exist including :-

• Issue of new shares - companies can fund a buyback using proceeds from a new share issue specifically arranged for this purpose which is popular when the company lacks distributable profits.

• Low value share buyback - private companies can utilise special rules for small buybacks up to £15,000 or 5% of share capital annually without requiring distributable profits. This requires a special shareholder resolution but provides flexibility for smaller transactions, particularly useful for employee share schemes.

• "Back-to-Back" arrangements - when a company lacks immediate funds, a new investor can purchase shares from the departing shareholder, with the company then buying from the new investor when funds become available.

• Deferred payment structures - companies can manage cash flow through deferred payment arrangements, with an initial payment followed by instalments. This requires comprehensive documentation of payment terms and often security for the selling shareholder. The tax implications need careful consideration as timing of payments can affect tax treatment.

• Interim dividend route - an alternative approach involves declaring an interim dividend to the selling shareholder which is then used to offset part of the purchase price. This reduces the immediate cash requirement for the buyback but requires careful consideration of tax implications and timing. The structure must ensure the dividend declaration is properly documented and legally valid.

Each funding method carries specific legal and tax implications requiring careful professional advice. The choice of method often depends on the company's financial position, timing requirements, and the commercial needs of all parties involved.

Share Buyback Agreement

A comprehensive buyback agreement forms the cornerstone of the transaction, protecting all parties' interests and ensuring legal compliance. Essential clauses include :-

• Purchase price and payment terms - including valuation method, timing of payments, and any deferred consideration.

• Warranties - including a clear statement that no third parties have rights over shares, powers to sell shares without third party consents and accuracy of information provided.

• Tax - indemnities protecting company against unexpected tax liabilities arising from the buyback,tax clearances required pre-completion, responsibility for tax on any deferred payments

• Completion mechanics - clear process for share transfer, payment and document execution.

• Confidentiality obligations - protecting sensitive company information and buyback terms.

• Post-completion restrictions - Restrictions on approaching customers/suppliers, ongoing assistance with tax matters, handover of relevant documents and obligations to resolve any outstanding matters.

• Entire agreement provisions - ensuring the Agreement is recorded as containing all agreed terms to prevent disputes.