Why buy back shares?

A company may decide to buy back its own shares for a number of reasons; however the two most common 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; or
• 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 involve shares listed on the open market and are therefore unlikely to be of relevance to private companies.

Legal Framework

Part 18 of the Companies Act 2006 (CA 2006) must be complied with when carrying out a share buyback. If a buyback is not carried out in compliance with these provisions, 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 to buy back its own shares 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); 
• whether the share buyback might give rise to a notification being required under the National Security and Investment Act 2021 (NSIA) (see "NSIA Consideration" below); 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 "Development 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 buy back.

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.

As noted above, shares bought back by a company generally must be paid for in full at the time of purchase. This can present a challenge where a company would seek to stagger the payments (for example, make the buyback more affordable). If a company does not want to pay for all of the buyback shares up front, then the buy back would have to take place in tranches, with payment for each tranche made in full each time and the selling shareholder retaining some of their shares until the final tranche has completed. Although this might make a buyback more affordable for a company, it is important to note that doing so will mean that the selling shareholder will retain the rights attaching to the shares they continue to hold (for example, voting rights or rights to dividends) until such time as their shares are fully bought back. 

The requirement to pay for shares in full also means that anti-embarrassment provisions should not form part of any buyback agreement. The payment of any uplift would likely constitute additional consideration, which would render the buyback agreement void as a result. A possible solution to this might be to have some of the selling shareholder's shares purchased by the remaining shareholders at the same time as the rest are bought back, with the remaining shareholders undertaking to pay a proportion of the uplift to the selling shareholder if their shares are sold for a higher value - though it is important to note that such an obligation would fall on those remaining shareholders in their personal capacity (i.e. and not on the company itself). 

Development of Rules

In 2013 and 2015, the Department for Business Innovation and Skills published new legislation intended to make it easier for companies to buy back shares held by their employees. The main changes were:

• 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 and these shares must be cancelled and not held in treasury;
• 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). Approval by an ordinary resolution now suffices (requiring approval by  members representing at least 50% of the total voting rights); and
• enabling private companies to defer payment for shares bought back pursuant to an employees’ share scheme.

NSIA Consideration

While the rules specifically relating to share buybacks have been fairly settled since the 2013 and 2015 regulations, one piece of legislation which may be worth considering when planning a share buyback is the NSIA. This Act provides for greater scrutiny of transactions that change the share ownership of companies which may have national security implications. The government has taken a greater level of interest in the control and share ownership of companies performing one of a number of specified activities, or active in certain business sectors.
The UK government has identified 17 "sensitive" areas of the economy, such as defence, energy and communications. If, following a proposed transaction, a shareholder in a company active in a "sensitive area" will:-

• hold more than 25%, 50% or 75% of the shares (or voting rights) in the company; or
• will be able to either secure, or prevent the passage of, any class of resolution made by the company,

then a notification to the government by that shareholder (but not the company) is legally required prior to the transaction taking place. Only after clearance is granted can the transaction proceed.
 
It is important therefore to know prior to a share buyback taking place whether a company falls within the scope of the NSIA provisions and whether the proportion of any shareholders' ownership of shares in the company will increase to the point where an NSIA notification becomes necessary. 

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.
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If you'd like to speak with us, please do not hesitate to contact our corporate team.