KNOWLEDGE

Share buybacks for private companies

Morton Fraser_Austin Flynn
Author
Austin Flynn
Partner
PUBLISHED:
02 December 2014
Audience:
Business
category:
Factsheet

A company can return value to its shareholders by buying back some of its shares. This is known as a 'share buyback' or a 'company purchase of own shares'.

Why buyback shares?

The two main reasons are to:

  • return surplus cash to shareholders, for example as a result of unexpected profitability or more cash than anticipated being available if potential expenditure has not occurred for some reason; and
  • provide an exit route for shareholders, for example where a shareholding employee ceases to be employed.

Types of buyback

The statutory procedure to be followed depends on whether the proposed buyback is an 'off-market' purchase or a 'market' purchase. A private limited company carrying out a share buyback will always make an off-market purchase. Market purchases are unlikely to be of relevance to private companies.

Legal Framework

Part 18 of the Companies Act 2006 ("CA 2006") must be complied with. In the event of contravention, the transaction will be void and an offence will be committed by the company and every officer in default.

Preliminary considerations

Consider:

  • whether the company's articles permit the buyback. Under CA 2006, a company will be deemed to have authority so long as the articles do not prohibit the buyback (previously, under the Companies Act 1985, the company's articles had to specify that buybacks were allowed);

  • whether there are any private agreements (e.g. shareholder agreements) which may prohibit the company's ability to purchase its own shares;

  • whether there are any pre-emption rights which restrict the transfer of shares e.g. there may be a requirement for the shares proposed to be bought back to be offered to existing shareholders before they can be transferred to the company. If triggered, these provisions would need to be complied with or amended before the company undertakes a share buyback;

  • whether there is any prohibition on giving financial assistance which could prevent the company from buying its own shares. Under CA 2006, a company may give financial assistance for the acquisition of its own shares so if there is any restriction on the giving of financial assistance in the company's constitution, this should be removed;

  • whether the company has more than one class of shares. Consider whether the buyback will result in the variation of the rights attaching to those classes of shares (in which case class consent to vary will be required); and

  • whether there is any banking facility which might restrict the company's ability to undertake a buyback.

Share capital requirements

There must be at least one non-redeemable share in issue after the buyback. Only fully-paid shares can be bought back.

Financing

A private limited company may finance an off-market purchase:

  • out of profits available for distribution;

  • out of the proceeds of a fresh issue of shares made for the purpose of such financing (the new issue must be made to fund the buyback and we suggest that the buyback is made at the latest within a few months following the issue of the new shares);

  • out of capital (as such a payment is potentially to the prejudice of the company's creditors, the company must follow a prescribed procedure when buying back shares out of capital which involves the directors making a statement specifying the amount of the capital payment for the shares and confirming that the company can pay its debts, a report by the company's auditors and publication of a notice in the Edinburgh Gazette and a national newspaper); or

  • with cash up to an amount in a financial year not exceeding the lower of £15,000 or the value of 5% of its share capital (see 'Recent relaxation of rules' below.)

Shares bought back by a company, other than under an employees' share scheme (see further below), must be paid for at the time they are purchased which means that deferring payment or payment by instalments is not possible.

Buyback contract

In order to make a share buyback, a company must enter into a contract with the shareholder(s) whose shares are to be purchased. It is usually a simple agreement providing for the company to purchase the shares or it can be a contract under which the company may become entitled or obliged to purchase the shares in the future subject to certain conditions being met. It need not be a stand-alone contract and can be incorporated into the company's articles as standing authority to buyback.

The contract for an off-market share buyback must be approved by the shareholders either before the contract is entered into or the contract must state that no shares will be purchased until its terms have been approved by resolution of the shareholders.

Recent relaxation of rules

In 2013, the Department for Business Innovation and Skills announced that it would publish new legislation intended to make it easier for companies to buy back shares held by their employees. The final regulations came into force on 30 April 2013. The main changes are:

  • a private company may finance a small buyback out of cash, without the payment having to be identified as being made from distributable profits (which was previously required under CA 2006). However, the company must be specifically authorised to do so in its articles;
  • the removal of the requirement for off-market purchases to be approved by members representing at least 75% of the total voting rights (special resolution). Now approval by an ordinary resolution will suffice (approval by  members representing at least 50% of the total voting rights); and

  • the removal of the requirement for the payment for the shares to be made 'on purchase' so that private companies can now defer payment for shares bought back pursuant to an employees’ share scheme.

Effect of buyback

  • The shares bought back are cancelled and the amount of the company's issued share capital is diminished by the nominal value of the cancelled shares (or the shares can be held in treasury);

  • The register of members must be updated;

  • Share certificates relating to the shares bought back will need to be cancelled;

  • Stamp duty must be paid by the company at the rate of 0.5% of the purchase price on purchases over £1,000;

  • Companies House filings must be made within 28 days of the buyback;

  • The company must update its accounts to reflect the change to the company's issued share capital or any relevant reserves; and

  • A copy of the buyback contract must be kept at the company's registered office for a period of 10 years following the buyback.

Disclaimer

The content of this webpage is for information only and is not intended to be construed as legal advice and should not be treated as a substitute for specific advice. Morton Fraser LLP accepts no responsibility for the content of any third party website to which this webpage refers.  Morton Fraser LLP is authorised and regulated by the Financial Conduct Authority.