Why undertake a share buyback?

A share buyback provides a company with a useful mechanism to create a market for shares when it may be difficult or undesirable to sell to a third party purchaser.  For example, a share buyback is useful to:

  • Facilitate the exit of a retiring shareholder;
  • Remove a dissenting shareholder; or
  • Prevent departing employees from continuing to hold shares in the company.

What happens to the shares?

Once the shares have been bought by the company, they can either be cancelled or, if the purchase was funded by distributable reserves, held in treasury by the company.

In practice, most private companies choose to cancel the shares following a share buyback as this reduces the total number of shares in issue which increases the interests of existing shareholders.

If shares are held in treasury they can be held indefinitely by the company, sold by the company, used as part of an employee share scheme, or eventually cancelled.

How is the purchase funded?

The payment for a share buyback by a private company must be financed out of distributable reserves, the proceeds of a new issue of shares, or (less commonly, and with more stringent requirements) out of capital.

Other requirements

The share buyback must be done in accordance with Part 18 of the Companies Act 2006 (CA 2006). Some of the requirements of Part 18 are that:

  • The shares being bought back must be paid for in full at the time of the purchase by the company;
  • The shares being purchased must be fully paid shares; and
  • There must be a contract which has been approved by a resolution of the shareholders either:
    • Before it is entered into; or
    • After it is entered into, provided that no shares can be purchased until it has been approved by a shareholders’ resolution.

However, in the limited circumstances where the share buyback is taking place for the purposes of, or pursuant to, an employees’ share scheme:

  • The shares may be paid for after the purchase or in instalments; and
  • A general authority for the purchase may be granted in advance by the members.

It is important to note that a failure to comply with Part 18 of the CA 2006 will result in the share buyback being void.  This can, therefore, give rise to a situation where the outgoing shareholder technically still holds its shares, but has also already received payment for them.  Trying to then resolve this at a later date will often, understandably, be difficult.

This article provides a high-level overview. In subsequent articles, we will explore specific aspects of share buybacks in more detail, including staged buybacks, their use in shareholder exits, and how share buybacks can be used for the purposes of employee share schemes.

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