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What is a buyback of shares? And how does it work?

If you own shares in a company and are thinking of selling them, getting the company to buy back your shares can be more tax-efficient than holding onto them and receiving cash from the company as dividends. Buybacks can be good for the remaining shareholders too, as their shares may be worth more following the buyback and they’ll receive a greater share of dividends. So, what’s a share buyback, and how can you go about one?

What is a buyback of shares?

A share buyback is where a company repurchases a current shareholder’s shares. There are generally a few conditions to meet if your company wants to buy back shares:

  • You need shareholder approval
  • There must be enough cash in the company to make the buyback
  • Funding for the buyback must come from the company

What’s the purpose of share buybacks?

Share buybacks are commonly used for the following reasons:

  • A shareholder leaves the company, wishes to retire or dies
  • 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 an external purchaser
  • The company is sitting on cash that isn’t needed for the foreseeable future
  • To raise the value of the remaining shares and increase dividends per share

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 retain cash, and shareholders may ask the company to return shares to them. Share buybacks are one option for returning cash, others include dividends and reductions of capital – the method you choose will depend on the tax situation of the company and shareholders.

Where a company is listed, a share buyback can:

  • increase its shares’ price-to-earnings ratio, earnings-per-share and net assets per share,
  • and decrease its gearing (ratio of debt to equity), 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?

If your company wants to buy back some of its shares, there are some rules to follow:

  • The company must have spare cash available to buy the shares after taking account of any tax due and owing
  • The shares that are bought back must be cancelled or held in treasury depending on the funds used to purchase them

In addition:

  • The articles of incorporation of the company must allow share buybacks
  • The company must pass a resolution to permit the buyback
  • The shareholders have to consent
  • The terms of the purchase need to be agreed
  • The company needs to decide how it will fund the purchase – this must usually be out of cash
  • The shares in question must be fully paid and not be the only non-redeemable shares in issue
  • Normally the shares must be paid for in full when they’re bought back from the shareholder

What are the benefits of buyback of shares?

In certain circumstances, share buybacks can be more tax-efficient for shareholders than receiving cash from the company as a dividend. In addition, for listed companies, share buybacks can push up the value of a company’s shares and increase the returns to existing shareholders from dividends.

What are the tax implications?

Generally, the amount a shareholder receives from a share buyback will be treated as a dividend and chargeable 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.

For shareholders who own 5% or more of the company’s shares and who are also directors or employees, any gain from the buyback of shares of a trading company can be treated as capital and taxed at 10%.

The conditions for the buyback to be treated as capital are:

  • The shares must have been held for five years or more
  • The selling shareholder must substantially reduce their holding
  • There must be a business case for the sale, and it not be part of a tax avoidance plan

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

Your company is free to agree a price with a shareholder who would like a buyback, although there are HMRC rules relating to share buybacks that you should observe if you’re seeking preferential tax treatment.

There are a number of ways that a company can fund a share buyback:

  1. From distributable profits
  2. From the proceeds of a new issue of shares issued to fund the buyback
  3. Out of capital, provided this is a small amount (de minimis), and in any financial year the lower of:
    1. £15,000, or
    2. 5% of the aggregate nominal value of its fully-paid share capital at the beginning of the financial year
  4. Out of capital using a special procedure (Part 18 of Chapter 5 of the Companies Act 2006)

What is the share buyback process?

There are various formalities to be completed and other considerations to bear in mind before a share buyback takes place.

Review of the company’s articles of association

A share buyback can’t take place if the company’s articles prevent the company from buying its own shares. If the articles contain such a clause, then they can normally be changed so that a share buyback is possible. In addition, if the company intends to buy its own shares out of capital using the de minimis exemption described above, the articles should be altered so that they allow this.

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 should 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, there may be special rules that apply enabling the company to permit delayed payment for shares, or payment by instalments, together with a simplified process for payment out of capital rather than retained profits.

Share buyback contract

When buying back shares, this should be set out in a share buyback contract that provides that the company will buy back its shares immediately or at some time 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. A copy of the buyback contract should be made available to the shareholders of the company so that they can examine it.

Shareholder approval

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 required.  If the resolution is written, then a copy of the buyback contract should be attached.

Payment

Unless the shares are being bought under an employees’ 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 by way of a permissible capital payment, then an additional special resolution of shareholders will be needed. 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.

Filings

These are the forms that need to be filed at Companies House after a share buyback:

  • Form SH03
  • Form SH06 for cancelled shares
  • Copies of any special resolutions passed

The register of members must be updated to reflect the buyback transaction, and a copy of the buyback contract must be made available for inspection. The company will have to pay stamp duty on the sale of shares if these are worth more than £1,000.


What next?

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 enquiries@hjsolicitors.co.uk, or fill out the short form below with your enquiry.

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