Times of economic uncertainty bring lots of worries for founders and business owners.
Some of these worries relate to the return of the money a founder has invested in the company.
Share buybacks allow a shareholder to release capital that they have invested in their business whilst at the same time concentrating ownership and potentially protecting that business from a hostile takeover.
Share buyback is a method available to both private and public companies.
- What is a share buy back?
- Why would a founder consider a share buyback?
- What are the benefits to the company of buying back your shares?
- What do you need to have in place for a share buy back?
- How is a share buy back funded?
- What due diligence is necessary for a share buy back to take place?
- What happens to the shares?
What is a share buy back?
A share buy back is where a company buys its own shares back from one or more of its existing shareholders and returns the corresponding capital to those shareholders.
The bought back shares are then taken off the market and can either be re-issued in the future or cancelled, depending on the circumstances.
There are a number of formal requirements that need to be followed for a share buy back to take place and these are covered in our in depth article.
It is always worth contacting your legal team who can support you in successfully navigating these formal requirements.
Why would a founder consider a share buyback?
The main reason you would consider having your shares bought back by the company is to take surplus cash out of that company. This can be particularly relevant in times of recession, as it allows you, as an individual, to reinvest that money elsewhere.
A share buy back has additional advantages, particularly relevant in times of economic uncertainty:
a) In relation to your tax returns, share buy backs can, in certain circumstances, be treated as capital rather than income, incurring a lower tax rate.
b) You don’t have to find a buyer for your shares. Buyers can be in short supply in an economic downturn.
c) You can access your capital where the other shareholders will not allow you to sell to a third party and don’t want to invest further by buying your shares themselves.
d) There is surplus cash in the company that is not needed elsewhere.
e) You wish to take action to ward off the potential for a hostile takeover.
What are the benefits to the company of buying back your shares?
Whilst you, as founder, may want to access your capital, there are also distinct advantages for the company in buying back your shares:
a) It deals with surplus cash: it is not efficient for a company to have surplus cash in the business without any planned use for that cash. This surplus cash might have resulted from continued profitability; business or assets sale or simply planned expenditure that has fallen through, perhaps due to the economic climate.
b) It returns cash to a shareholder or shareholders other than by increasing dividends.
c) It allows a shareholder or shareholders to exit the business and therefore concentrates ownership on the shareholders that wish to continue, simplifying voting and claims to capital going forwards.
d) It raises the value of the remaining shares and increases the amount of dividends per share. This is particularly relevant in times of economic uncertainty when there may be hostile takeovers and companies looking to buy ‘on the cheap’.
e) For listed companies, there are additional advantages in terms of increasing earnings per share, gearing, preserving share prices and reducing the cost of capital.
f) In a period of market volatility, share buy back is a relatively safe use of spare cash compared to investing in new technology, acquiring a competitor or leaving it in the company to be utilised by the management team.
What do you need to have in place for a share buy back?
There are three basic requirements for a share buyback to take place:
a) Approval of the other shareholders.
b) Cash in the company to fund the buyback.
c) The company must provide the cash to fund the buyback.
How is a share buy back funded?
In the case of a private company, a share buy back must be an off market purchase and can be funded by one of the following means:
a) from distributable profits;
b) from the proceeds of a fresh issue of shares which has been made specifically to finance the share buy back.
c) out of capital, if there are no profits available.
d) with cash up to the value in any financial year of the lower of £15,000 and 5% of the company’s share capital. In this instance, shares must be repurchased at their nominal value.
Additional rules apply to the funding of share buy backs where premiums are payable.
In most instances, shares purchased by the company must be paid for there and then and cannot be deferred or paid for in instalments.
What due diligence is necessary for a share buy back to take place?
There are a number of important steps to take to allow your company to purchase your shares:
a) check that your company has sufficient cash or funding in place for the buyback and considering any upcoming financial liabilities.
b) check that your Articles of Association allow a share buy back and if there are any special conditions that have to be fulfilled to do so.
c) agree the terms of the buyback in a share buyback contract between the company and the shareholder or shareholders whose shares will be purchased.
d) gain the approval of the shareholders to both the principle and terms of the buyback either in a shareholders meeting or by written resolution.
e) pay out the cash.
f) cancel the shares or hold them to be reissued in the future
g) file the necessary forms at Companies House to update the public records.
It’s important to seek legal advice so that your legal team can support you in going through these steps so that your share buyback is valid and effective.
What happens to the shares?
Once the company has bought back the shares, they are either cancelled and the issued share capital reduced or held in treasury to potentially be reissued in the future.