What is a share buyback?
A share buy-back is the purchase by a company of its own shares from the existing shareholders. Once a company has completed the share buyback, the shares are then usually cancelled. The effect is that there will be fewer shares in circulation, so the percentage shareholding rises pro rata and the year end dividend per share is higher for the remaining shareholders.
What is the purpose of a share buyback?
A share buyback can be an advantageous solution in a range of circumstances. Firstly, the chairman of a family business may wish to retire and to pass the baton onto the next generation. However, the next generation may not have sufficient funds available to buy-out the retiring shareholder. If the retiring shareholder needs the value in his shares to fund retirement a buyback can avoid the next generation from seeking bank funding.
A second scenario where a buyback can be an appropriate solution is if there has been a breakdown in the working relationship between shareholders of a company. If the company’s articles of association or any existing shareholders’ agreement do not provide an appropriate compulsory share transfer mechanism or resolution mechanism, a share buyback by the company can provide an appealing exit route.
In both examples, an exit route is provided for the outgoing shareholder without a personal cost to the remaining shareholders and without the introduction of a new, third party shareholder.
Thirdly, the company may simply have surplus cash, perhaps following the sale of a business or the retention of profits.
Central to most share buybacks is that the company must have sufficient distributable profits and therefore appropriate legal and accounting advice should be sought.
How is a Share buyback achieved?
The company must not be prohibited from effecting a share buy-back by its articles of association, or prohibited from providing financial assistance for the acquisition of its shares. If such a prohibition does exist, it will be necessary to amend the articles of association by way of special resolution of the shareholders, requiring the approval of 75% of the votes attaching to the shares in issue. Assuming the articles do not provide such an obstacle, the company must then navigate its way around section 658 of the Companies Act 2006. This contains a general prohibition against a company acquiring its own shares unless a set procedure is adhered to.
To begin with, a share buyback agreement should be produced. This is an agreement between the company and the shareholder whose shares are to be bought-back. The agreement can be relatively straightforward, setting out the quantity of shares to be bought-back and the price at which they will be purchased. There is no limit or cap on the number of shares that can be subject of a buyback, provided that there is at least one fully paid-up share remaining in issue following the buyback and that it is held other than by the company. The company can not be the sole shareholder in itself.
Before it is entered into, the buyback agreement must then be approved by a special resolution of the members, whether in general meeting or by way of a written resolution. The shareholder whose shares form the subject of the buyback agreement will not be able to participate in the vote on the resolution. Once approved, the buyback agreement can be signed by the parties and the signed version must then be made available for inspection at the company’s registered office address.
One important point to note is that the consideration for the shares being bought back must be paid for when the buyback agreement is entered into - it is not possible for the payable to be deferred. It is possible to provide for a multiple completion buyback, whereby a Company purchases legal title to the shares at completion and then beneficial title to the shares passes on certain future dates when the payment of consideration is made. Such a solution is capable of being challenged by HMRC as a buyback agreement must, from a company law perspective, be conditional upon the company having sufficient distributable profits to complete the buyback. However, from a tax perspective, the contract must be unconditional. Multiple completion buybacks are however becoming increasingly popular, but specific tax advice should be sought in advance.
Once the buyback has been approved by the shareholders, sanctioned by the board of directors and then completed, the company pays the consideration to the outgoing shareholder and stamp duty at the rate of 0.5% (unless the price is £1,000 or less) is paid on a Form SH03 and then filed at Companies House and the statutory books of the company must be updated. The shares which formed the subject of the buyback are then cancelled and the buyback agreement must be made available for inspection at the company’s registered office address for at least 10 years.
The consequences of not adhering to the provisions of Part 18 of the Companies Act 2006 are potentially severe - the buyback will be void and the company and each officer in default is liable to a prison term of up to two years or an unlimited fine or both. It is therefore important to obtain suitable legal and taxation advice before proceeding with a share buyback.
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Please note that the information and opinions contained in this article are not intended to be comprehensive, nor to provide legal advice. No responsibility for its accuracy or correctness is assumed by Pearson Solicitors and Financial Advisers Ltd or any of its members or employees. Professional legal advice should be obtained before taking, or refraining from taking, any action as a result of this article.
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