What is share buyback?
Simply put, a share buyback is where a company buys some of its own shares from existing shareholders. Henry Catchpole explains all.
There are three different types of share buyback: purchase of own shares; share redemption; and share capital reduction by cancelling or repaying shares. Here we focus only on purchase of own shares.
Why carry out a share buyback?
There are various circumstances where a company may want to buy back its own shares – where shareholders retire, die or no longer want to be involved with the company and the remaining shareholder(s) are unable to buy the shares and do not want any other parties to own them or a third-party purchaser cannot be found. This type of situation is often covered by the terms in a shareholders’ agreement.
Other reasons include:
- returning excess cash not needed for the company’s ongoing operations to the shareholders.
- taking advantage of what is seen as an undervaluation of the shares.
- for public limited companies, to increase the value of the remaining shares, increase the dividends per share or help maintain a market in the shares.
How does it work?
The rules for share buybacks are set out in Part 18 of the Companies Act 2006.
When considering a purchase of own shares, the directors need to ensure that a number of conditions are met:
- the Articles of Association do not prohibit share buybacks (they can be amended to allow a share buyback by passing a special resolution).
- a company cannot buy back all of its own non-redeemable shares.
- the shares being bought must be fully paid.
- the shares bought back must generally be paid for by the company on purchase unless being bought as part of an employee share scheme.
How to finance a share buyback
There are three ways that a company can fund a share buyback. The easiest way is for the company to use its distributable profits and the proceeds of any new issue of shares.
A private limited company may also make a small purchase of its own shares out of capital if it does not have sufficient distributable profits up to an aggregate purchase price in one financial year of the lower of £15,000 or 5% of the aggregate nominal value of its fully paid share capital as at the beginning of the financial year.
Finally, it is also possible for a private company to make a permissible capital payment to purchase its own shares. In this case there are steps the directors need to follow which are beyond the scope of this article.
A company can use a combination of the above but you must always use distributable profits and the proceeds of any new issue before making a payment out of capital.
Is shareholder approval needed?
The company’s shareholders need to approve a share buyback, usually by passing an ordinary resolution. However a special resolution will be required if the articles either do not allow purchases of own shares or specifically require one for a purchase of own shares or the purchase is being financed out of capital.
Where the shareholder resolution is to be voted on at a shareholders’ meeting, a copy of the proposed contract of purchase or written details of the terms – if the contract is not in writing – must be available for inspection at least 15 days before the date of the meeting at which the resolution is to be passed. Where it is to be a written resolution, a copy of the contract or written details of the terms must be sent with the written resolution.
The shareholders whose shares are the subject of the buyback cannot exercise the votes attached to those shares.
For the seller, the amount paid for the shares by the company can have taxation implications, with any amount over the initial issue price normally treated as a distribution and as taxable income, not as a capital gain.
For the company, stamp duty is payable by the company on the purchase of shares if the total consideration exceeds £1,000. For off-market purchases, this is calculated at 0.5% rounded up to the nearest £5 of the purchase price paid by the company.
Reporting the buyback
Once the buyback has been made the Companies House form SH03 should be completed, and sent with a cheque for the stamp duty if payable, to HM Revenue & Customs (HMRC) for stamping and then to Companies House within 28 days.
If the shares are being immediately cancelled, then in most cases form SH06 should also be filed at Companies House within 28 days. Where the company is a public limited company and section 663 of the Companies Act 2006 applies, form SH07 should instead be filed at Companies House. Also where the purchase of own shares is being treated as a capital return, a return under section 1046 of the Corporation Tax Act 2010 should be completed and sent to HMRC within 60 days.
In addition to completing the above forms, the company should update the register of shareholders and other similar records for shares bought and cancelled by the company from each shareholder.
It should also update the accounting records for the shares bought and cancelled and cancel the share certificates for the shares bought back, issuing new share certificates where the shareholders still have a holding after the buyback.
Finally, the company must keep a copy of the contract to purchase its own shares or a memorandum of its terms – if this was not in writing – for ten years, available for inspection at its registered office by shareholders and if a public company, by any other person.
- Henry Catchpole is CEO of Inform Direct
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