Company share buyback overview

Share buybacks are mechanisms for managing share capital and shareholder exits in private companies. A share buyback agreement can be used to return value to investors, remove exiting shareholders, restructure ownership, or increase earnings per share for remaining shareholders. A buyback of shares is quite common with owner-managed businesses and companies with employee shareholders.

Contact us for advice on your potential share buy back.

Reasons for company repurchase of shares

In our experience, the majority of share buybacks in private companies occur when employees or directors leave a business and especially where a founding shareholder retires, or where employees with shares in a share scheme leave or with family businesses, managing generational transition.

Other reasons for a buyback include :-

• Restructuring or simplifying share capital - to reduce the number of shareholders or consolidate share ownership among key stakeholders.

• Returning surplus cash to shareholders - if the company has accumulated surplus cash and no immediate reinvestment opportunities, a buyback allows the company to return excess capital to shareholders and is an alternative to dividends.

• Resolving shareholder disputes - in situations where there are disputes or irreconcilable differences between shareholders, a buyback can offer a clean exit for one or more parties, preserving the company’s operational stability.

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 :-

• Fresh issue of shares - companies can fund a buyback using proceeds from a new share issue specifically arranged for this purpose. The new issue must occur in close proximity to the buyback to maintain the connection between the funding and the purchase. This proves particularly useful when the company lacks distributable profits, though it requires willing investors to subscribe for the new shares.

• 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. This arrangement requires careful structuring to avoid financial assistance issues but can provide a practical solution for timing mismatches.

• Deferred payment structures - companies can manage cash flow through deferred payment arrangements, with an initial payment followed by installments. 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.

• Multiple completion dates - breaking the purchase into stages through a series of smaller buybacks can help match the company's cash availability. This requires precise structuring to ensure enforceability of the overall arrangement and clear triggers for each completion stage. Care must be taken to maintain the commercial cohesion of the transaction.

• 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.

Key tax considerations

The tax treatment of share buybacks requires careful navigation as it can significantly impact both the company and the departing shareholder. While buybacks can offer tax advantages compared to traditional share transfers, incorrect structuring can result in unexpected tax charges.

The key challenge lies in determining whether the buyback will be treated as a capital or income distribution.