If you’re the founder of a private company and need cash for a new project or simply want to release surplus cash to shareholders, one potential route of releasing value is for the company to buy back its shares. However, the rules around share buybacks are strict and complex, since depriving a company of capital can be a way to avoid creditors and, perhaps, tax. Make sure you get tax and legal advice before starting the process and learn more about it below.
Contents:
Benefits of share buybacks
For the company
Sometimes a business can find itself sitting on more cash than it needs for its day-to-day activities. Because retaining cash without a plan for it isn’t usually efficient, you may consider returning it to shareholders in exchange for some or all of their shares, as opposed to declaring a dividend, or reducing the company’s capital.
If your company buys back its shares when underperforming, it can re-issue more shares when conditions improve for a higher amount. What’s more, a share buyback can make a company look more attractive to investors, since it’s a signal that the business no longer needs equity funding and is financially healthy.
For the shareholders
Sometimes share buybacks can be more tax-efficient for shareholders than receiving dividends. Share buybacks push up the value of the company’s remaining shares since the bought-back shares are (usually) cancelled, thus increasing the remaining shareholders’ share of the pie. This can also increase their proportion of dividends.
Share buybacks can also be a useful method to exit a company, for example, a shareholder wants to retire or move on to new things and can’t find a buyer for its shares or an employee wants to leave. A company share buyback enables ongoing shareholders to exit a shareholder without having to personally find the funds to purchase the outgoing shareholder’s shares.
In tax terms, sometimes share buybacks can be treated as being chargeable to capital gains tax rather than income tax in the hands of shareholders, and may also benefit from Business Asset Disposal Relief, for example, where a company buys back its shares from a shareholder who owns 5% or more of shares (with full rights attached to them) and who are also directors. However, certain conditions must be met, and you should speak to your tax advisor about this. It is also worth noting that advance clearance of the tax treatment can be sought from HMRC.
Funding routes for share buybacks
Your company is free to agree a price with a shareholder for the buyback of their shares, although, again, there are HMRC rules relating to share buybacks that you should observe if you’re seeking preferential tax treatment so you will need to speak to your tax advisor.
There are a few ways that a company can fund a share buyback:
- From distributable profits
- By borrowing
- From the proceeds of a new issue of shares, issued to fund the buyback
- Out of capital, provided this is a small amount (de minimis), and in any financial year the lower of:
- £15,000 or
- 5% of the aggregate nominal value of its fully paid share capital at the beginning of the financial year; or
- Out of capital (above the de minimis thresholds), using a special procedure
The simplest way of funding a share buyback is to use the company’s cash reserves. This is particularly good when interest rates are low, and it doesn’t have any high-return investment opportunities. It’s simple, and there are no additional costs like interest to pay.
A company can also borrow to buy back its shares, and this can be efficient when interest rates are low, and the borrowing costs are less than the return on equity gained from reducing the number of shares. The interest payments will usually be tax deductible, and the company can hold on to cash to invest in new projects. Or you can use a combination of debt and cash, balancing the need to return capital while maintaining financial efficiency. This avoids over-leveraging or depleting cash reserves.
You could also sell under-utilised assets to fund a buyback and redeploy the capital to benefit shareholders. This unlocks value from the assets and keeps debt and cash levels within manageable limits.
Generally, issuing new shares is an inefficient way to buy back shares, as it dilutes existing shareholders and can be viewed negatively by potential investors.
Legal considerations for share buybacks
A share buyback isn’t a DIY affair; the process can be complicated and there are strict rules to follow if you want to avoid wasting time, money and the painful unintended consequences of getting it wrong. For example, you can’t do a share buyback if the company’s articles forbid it, so you’ll need to change them.
Also, if you want to buy shares out of capital and follow the special process, you may need to change the articles to allow this. In addition, the articles or a shareholder’s agreement may require you to first offer the shares to other shareholders before they can be sold to the company. Although there is no third party buyer to consider with a company share buyback, unless the buyback is pursuant to an employees’ share scheme, you’ll need to prepare a share buyback contract setting out the terms of the buyback and the following key requirements must be met:
- Shareholder approval is required
- The shares being repurchased must themselves be fully paid up
- Consideration for the share buyback must be paid in cash at the time of the purchase (you can’t defer payment over a period of time)
- The buyback can only be funded as set out above.
- The shares bought back must be cancelled, unless they were financed using the Company’s distributable reserves, in which case they can be held in treasury for future issue.
You’ll also need to make ensure the proper filings are made at Companies House, update the register of members, and ensure that a copy of the buyback contract is made available for inspection at the company’s registered office address. The Company will also need to pay stamp duty on the amount of the consideration it paid for the shares, if more than £1,000.
What to do if you need help with a share buyback
Your legal advisor will play a pivotal role in making sure the buyback process complies with the complex legal and regulatory requirements. Our involvement is vital to avoid legal pitfalls, protect the company and its directors, and ensure a smooth process.
We will review and make sure that you constitutional documents enable the purchase, work with your accountant, financial and/or tax advisor to ensure the desired funding route is available and also help you explore alternative methods such as capital reduction.
We will also advise on, prepare and review all the required documents, such as board resolutions, shareholder resolutions and the buyback agreement. We can amend the articles if needed and prepare all the necessary forms and filings and get these filed at Companies House for you, as well as assist with the payment of any Stamp Duty payable.
To find out more, and to get advice on share buybacks, consult our corporate solicitors. Get in touch on 0800 689 1700, email us at enquiries@harperjames.co.uk, or fill out the short form below with your enquiry.
