If a company is sitting on cash that it doesn’t need to run its business or expand, it can sometimes be beneficial for it to buy back some of its shares rather than return that cash to shareholders in the form of dividends.
This is for two reasons: firstly, in certain circumstances, the money shareholders receive for their bought-back shares can be treated as capital rather than income, so they’re taxed at a lower rate. Secondly, the remaining shareholders’ shares will be more valuable after the buyback since the bought-back shares are cancelled so they own a larger piece of the pie. What’s more, they’ll receive a greater share of dividends.
So, what’s a share buyback, and how can you go about one?
- What's a buyback of shares?
- Why would a company buy back shares?
- How does buyback of shares work?
- What are the benefits of buyback of shares?
- What are the tax implications of a share buyback?
- How to fund a company share buyback
- What is the share buyback process?
What's a buyback of shares?
A share buyback is where a company exchanges some of its spare cash in return for its issued shares. After a share buyback, those shares are cancelled, and the remaining shareholders are left with a larger individual share of the company.
If you want to carry out a share buyback, you need to meet certain rules:
- You need to get the approval of the shareholders
- You must have spare cash on the company’s books to fund the buyback
- The money for the buyback must come from the company
Why would a company buy back shares?
A share buyback is essentially a dividend coupled with a return of shares. So why not just declare a dividend?
The reason is that share buybacks can be treated as capital rather than cash in the hands of the shareholder exiting the company. And capital is taxed at lower rates than income.
Share buybacks are commonly used where:
- A shareholder wants to exit the company by retiring
- A shareholder wants to sell their shares, but the existing shareholders don’t want to buy them (or allow that shareholder to sell to someone else)
- A shareholder wants to sell but can’t find a buyer
- The company is sitting on cash it doesn’t need
- The company wants to raise the value of the remaining shares and increase dividends per share (possibly to ward off a hostile takeover)
A company may have more cash than it needs because it has recently sold part of its business or is generating very high profits for example. It’s usually not efficient for a company to hang onto cash, and shareholders may ask the company to return shares to them.
Where a company is listed, a share buyback can (i) increase its shares’ price-to-earnings ratio, earnings-per-share and net assets per share, and (ii) decrease its gearing (ratio of debt to equity), thus increasing the shares’ value. Share buybacks in listed companies can also help to increase demand for the shares, as their value increases as a result of the buyback. This article deals mainly with share buybacks from private limited companies (off-market share buybacks).
Share buybacks can be complicated and you should take legal and tax advice before starting the procedure, as a failure to comply with the legal rules can mean the share buyback is unlawful and void.
How does buyback of shares work?
It’s important to take legal advice if you want to carry out a share buyback. This is because unless you follow certain rules, the transaction will be void. The process is described in more detail below.
Here is a brief outline:
- Check your company’s Articles to make sure share buyback are allowed
- Make sure you have enough cash to make the share payment, bearing in mind any other upcoming payments such as tax liabilities
- Set out the terms of the share buyback in an official buyback agreement
- Ask your company’s shareholders to agree to the share buyback by way of a company resolution
- Pay out the shareholder and cancel the bought-back shares (or put them into treasury)
- Make the relevant filings at Companies House
What are the benefits of buyback of shares?
There are several benefits of a share buyback. Where a private limited company buys back shares, rather than declaring a dividend, the cash in the hands of the selling shareholder can be treated as capital so liable to capital gains tax rather than income.
In addition, for listed companies, share buybacks can have the effect of raising the share price and earnings per share.
What are the tax implications of a share buyback?
Generally, cash received by shareholders in relation to the shares they hold is treated as a dividend and thus liable to income tax. However, in certain circumstances, share buybacks can be treated as being chargeable to capital gains tax (CGT) rather than income tax. Stamp duty may be payable on the sale transaction.
Shareholders holding 5% or more of a. company’s shares and who are also directors or employees, that sell back those shares to the company can have that windfall treated as capital provided that:
- They’ve owned the shares for five or more years
- They substantially reduce or eliminate their shareholding
- There’s a valid business reason for the sale, i.e. it’s not just a tax avoidance scheme
Note that this is a very general outline of the tax position, and you should take expert tax advice before proceeding with a buyback of shares.
How to fund a company share buyback
There are several ways that a company can fund a share buyback:
- from distributable profits
- 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
- out of capital using a special procedure (Part 18 of Chapter 5 of the Companies Act 2006)
What is the share buyback process?
As we’ve seen, you have to go through a few formalities before you can do a share buyback.
Review of the company’s articles of association
Unless your company’s Articles allow them, you can’t do a share buyback. If your Articles prohibit them, you’ll need to change them first. In addition, if you want to use the de minimis example to fund the buyback out of capital, you’ll have to amend them to permit this too.
You also need to check the Articles to see if there are any rights of pre-emption or restrictions on share transfers that might be activated by a share buyback, for example, that existing shareholders must be offered the shares before they are sold to the company.
Employees’ share schemes
Where share buybacks are being used under an employees’ share scheme, you may be able to delay payment for the bought back shares, or even pay for the shares by instalments. There’s also a simplified process for payment out of capital rather than retained profits.
Share buyback contract
When buying back shares, you need to prepare a share buyback contract in which the company agrees to buy back its shares immediately or in the future. It will contain the names of those selling their shares, the types of shares being sold and the price for those shares. You will need to show a copy of the buyback contract to your shareholders.
The shareholders must approve the share buyback either at a general meeting or by written resolution, and if the company intends to buy the shares out of capital, an additional resolution is needed. If the resolution is written, you’ll need to attach a copy of the buyback contract.
Unless the shares are being bought under an employee shares scheme, they should be paid for when they are purchased, and usually in cash and out of distributable profits.
If the company will be purchasing out of capital, you’ll need an additional special resolution of shareholders. In addition, if the company will be purchasing out of capital under Chapter 5, then there are additional procedures to be followed including a public notice, an auditor’s report and a directors’ declaration of solvency.
Bought back shares
Shares that have been bought out of profits may be cancelled or held in treasury, and those bought out of capital must be cancelled. When the shares are cancelled, the company’s issued share capital is reduced.
These are the forms you need to file at Companies House after a share buyback:
- Form SH03
- Form SH06 for cancelled shares
- Copies of any special resolutions passed and a copy of the Articles if they’ve been amended
You’ll also need to update the register of members to reflect the buyback transaction. The company will have to pay stamp duty on the sale of shares if these are worth more than £1,000.
For more answers to commonly asked questions and advice on share buybacks, consult our corporate solicitors. Get in touch on 0800 689 1700, email us at email@example.com, or fill out the short form below with your enquiry.