A company may decide to purchase shares in itself from an existing shareholder in order to return surplus cash to its shareholders or to facilitate an exit route for shareholders seeking to leave the company. This is known as a "share buyback" and this blog is a useful reminder of some key considerations when carrying out a share buyback. It focuses, in particular, on share buybacks carried out by private limited companies.
Why do companies carry out share buybacks?
1. To return surplus cash to shareholders
If a company has accumulated surplus cash reserves, perhaps as a result of the sale of a business or having funds earmarked for a potential acquisition or planned expansion that has fallen through, a share buyback can return some, or all, of that cash to the shareholders, avoiding the inefficiency of holding excess cash in the company without any planned use.
2. To provide an exit route for shareholders
Where a shareholder wishes to exit the company and the remaining shareholders do not wish to purchase the shares owned by the departing shareholder, the company can repurchase the shares itself. This ensures that a third party does not acquire a stake in the company and the remaining shareholders do not have to pay any money directly to the departing shareholder.
A buyback can also be used to purchase shares issued to an employee under an employee share scheme when such employee ceases to be employed by the company.
3. To increase their gearing ratio
A share buyback will allow a company to increase its ratio of debt to equity and thereby increase its leverage, since buying back shares followed by cancelling them will reduce the amount of equity held in the company.
How are share buybacks funded?
There are several ways in which a company can fund a share buyback:
1. Distributable reserves
Instead of distributing profits in the form of dividends, a company may use its accumulated profits to buy back shares. This is the most straightforward way to achieve a share buyback for a private limited company.
2. New share issue
A company may choose to issue new shares and use the subscription money to finance a share buyback. In doing so, the company must demonstrate that the purpose of the new share issue is solely to finance the share buyback. This can be achieved by enacting the share buyback shortly after the share issue takes place, in order to demonstrate a link between them.
3. Using the capital of the company
Subject to any restriction or prohibition in its articles, a company can purchase its own shares out of capital. This is the most complicated method of financing a share buyback as a payment out of capital puts the company at greater risk of insolvency and could be prejudicial to the interests of the company's creditors. As such, any company wishing to purchase shares out of capital must follow the prescribed procedure detailed under Chapter 5 of Part 18 of the Companies Act. There is a de minimis exception available which permits the purchase of small amounts of shares out of capital without having to follow the procedure in the Companies Act 2006. To take advantage of the de minimis exemption, a company must have express authority to do so in its articles.
How do share buybacks work?
Part 18 of the Companies Act 2006 sets out the procedure that must be followed to give effect to a share buyback. Failure to adhere to the prescribed procedure could render the transaction void and will constitute a statutory offence by the company and every officer in default.
Some of the requirements under this procedure are:
1. The transaction must be permitted under the company's articles of association (and any relevant shareholders' agreements) which should be reviewed in the first instance to ensure that they do not actively prohibit or restrict the company from purchasing its own shares. Where a company's articles contain an express prohibition or restriction on share buybacks, the articles may be amended by special resolution of its shareholders.
2. The articles (and any relevant shareholders' agreements) should be checked to ensure that there are no pre-emption provisions which may require shares to be offered to the existing shareholders before they can be transferred to any other party, including the company. If applicable, these provisions would need to be complied with, waived or amended prior to the buyback taking place.
3. The transaction must be documented in an express agreement between the company and the selling shareholder which is approved before the company undertakes the share buyback. Unless the articles provide otherwise, the agreement can be approved by the company's shareholders via an ordinary resolution. The directors can choose to obtain this approval at a general meeting or via a written resolution.
4. The shares which are to be purchased must be fully paid up and the shares generally must be paid for at the time of purchase. If the company does not have the funds to pay for all of the shares at once, it is possible for the shares to be purchased in tranches. Although this might make the buyback more affordable for the company, it should be borne in mind that the selling shareholder will retain the rights attaching to the shares they continue to hold until the buyback is completed in full.
There are also a number of post-buyback requirements that must be complied with including payment of stamp duty, updating the register of members and making the appropriate Companies House filings. See our previous blog for a useful summary of these requirements.
Employee share schemes
Where a company is proposing to carry out a share buyback pursuant to an employee share scheme, it may wish to take advantage of certain statutory relaxations introduced by the Buyback Regulations 2013.
1. General shareholder authority
A company can pass an ordinary resolution to grant a general authority under which it can carry out multiple buybacks in the future. This eliminates the need for a share buyback contract between the company and every selling shareholder.
2. Timings and methods of payment
Shares do not require to be paid for at the time of purchase and the purchase price can be satisfied by non-cash consideration such as loan notes.
3. A simplified process for buying back out of capital
The 2013 Regulations simplified the procedure for private companies financing share buy backs out of capital pursuant to employee share schemes by enabling these to be authorised by a special resolution and a solvency statement, removing the requirement for a supporting auditors' report and directors’ report.
How Brodies can help
Our Corporate team regularly advise on all aspects of share buybacks including share buybacks pursuant to employee share schemes. If you are considering effecting a share buyback, or have any related questions, please get in touch with your regular Brodies contact or one of the contacts listed below.
