What is a company share buyback and how does it work?

A share buyback is an action by which a company purchases its own shares from its shareholders. A limited company may buy back shares in itself if certain conditions set out in the Companies Act 2006 (CA 2006) are met.

Under the CA 2006, a company may buy back its shares either through an off-market purchase or a market purchase. The statutory procedure to be followed for a share buyback will differ depending upon whether it is to take place on-market or off-market. There is a strict statutory procedure that must be complied with if a company is to buy back shares. Therefore, specialist legal advice should be taken to confirm all statutory requirements are met.

Please note that depending on the nature of your business and the transaction, the requirements may differ. Therefore you should not take this briefing note as legal advice, and you seek assistance from our Corporate team upon your specific circumstances.

Why purchase shares back?

A company may wish to purchase shares back in order to:

1. To return surplus cash to shareholders.

A company may have surplus cash due to outstanding profitability, the sale of a business, having cash in readiness of a potential acquisition or planned expansion that has fallen through. It is not efficient for a company to have excess cash without any planned use and shareholders are likely to want a return on their investment. A buyback is one method of returning cash to shareholders, and this method will often be driven by tax considerations.

2. To provide an exit route for shareholders.

A buyback can be used to facilitate the exit of a shareholder from a company, especially in the following circumstances:

3. When a shareholder wishes to exit a small company

A private company may have a small number of shareholders with one wanting to exit. In such a case there may be provisions in the company’s articles preventing the shareholder from selling his interest to a third party (at least in the first instance) and specifying that, if the remaining shareholders do not want to purchase the shares from the party seeking to exit, the company can repurchase the shares itself. This way, a third party does not gain an interest in the company, and the remaining shareholders do not have to pay any money directly to the exiting member.

4. When an employee ceases to be employed by the company

A buyback can be used to purchase shares issued to an employee under an employee incentive scheme when he ceases to be employed by the company.

5. Company de-lists

A buyback effected by means of a tender offer can be used to give shareholders an exit route where a company is intending to cancel the listing or quotation of its shares. This is more common in relation to companies with shares traded on AIM but has also been used to cancel a listing of shares listed on the Main Market.

Funding the buyback

Once a limited company chooses to buyback specific shares, the appropriate funding for the shares will be necessary. The buyback must be off market and are typically funded by the following:

• From distributable profits;
• From the proceeds of a fresh issue of shares made specifically for the purpose of financing the buyback;
• Out of capital (where the company has used all of its available profits); or
• With cash up to the value in any financial year of the lower of £15,000 and 5% of the company’s share capital. When funding a buyback out of cash in this manner, shares must be repurchased at their nominal value.

Where a premium is deemed payable on shares, this premium will need to be provided by distributable profits, except in the case whereby the shares that are being purchased where initially bought at a premium. If this is the case, any premium payable as consideration for the shares can be provided out of the proceeds of a fresh issue of shares, to a certain limit.

When a limited company chooses to buy back shares, any amount paid for the purchase that amounts to more than the original subscription for the shares will be subject to tax as an income distribution. Although, there is relief available from tax on income on the distribution in certain situations where a company purchases its own shares. 

When applicable, the share buyback is dealt with as a capital transaction for the shareholder, which will be more efficient in some circumstances (for example entrepreneurs relief could reduce the effective rate of tax down to 10%). It is necessary that you seek specialist accountancy advice in respect of the tax of a share buyback and if the company will need to apply to HMRC for clearance.

When shares are purchased by a limited company must be paid for at the time that they are purchased if the transaction is a share buyback. Therefore, there cannot be any payment schemes or deferred payments; consideration must be paid in full.

The share buyback agreement

A limited company can only make an off-market purchase of its own shares if there has been a formal contract approved by the shareholders before the purchase or, where the purchase is for the purposes of or pursuant to an employees’ share scheme, under a general authority given by the shareholders. In some cases, there may be supplementary approvals and notices required if the purchase is going to be funded out of capital.

The share buyback agreement will set out the main terms of the repurchase of the shares. It is a contract between the company and one or more shareholders whose shares are to be bought back. A copy of the share buyback agreement must be made available to the shareholders before and after it has been approved.

Whilst the agreement can be a very simple contract providing for the company to purchase the relevant shares or, depending on the complexity of the matter, it could be an agreement under which the company may become entitled or obliged to purchase the shares in the future, subject to certain conditions. It may also be necessary to include additional provisions in the contract to protect the companies interest.

It may also be advisable to include further terms in the contract in certain conditions, such as restrictive covenants on outgoing shareholders and confidentiality provisions. These are often considered vital in order to protect the goodwill of the business.

Further to the contract, the additional documents required for a share buyback include:

Board meeting notices for members

Subject to the company’s articles (which must be checked – further detail of this is to follow), notice of a board meeting must be given to all directors. If notice is not given to all directors, the proceedings at the meeting may be invalid. Subject to anything contrary in the articles, the period of notice given to directors for a board meeting must be reasonable. This will depend on the circumstances, i.e. how urgent it is and the usual practice of the board.

Board meeting minutes to seek members’ approval for a share buyback

The only statutory provisions affecting board meetings is section 248 of the CA 2006, which requires minutes of board meetings to be kept. If the company fails to comply with section 248, an offence is committed by every officer of the company who is in default.

A special resolution to approve a share buyback

This can be passed either:

• As a written resolution: where the directors’ statement, auditors report and written resolution must be sent to all members at the same time. The resolution must be passed within one week of the directors’ statement and should state the date in which it needs to be passed along with what happens if the requisite number of votes isn’t met. The individual with the shares in question will not be able to vote.
• At a general meeting: where a copy of the directors’ statement and auditors report must be available for inspection at the meeting (instead of 15 days before). The voting restrictions imposed on the selling shareholder for the buyback contract also apply to voting on paying for the shares out of capital.

Please note that even if you are the only director or shareholder of your business, you must still hold “meetings” and document the resolutions made – with yourself! This is a mere formality that abides by corporate compliance regulations.

Copies of company resolutions and board minutes must be kept for at least ten years from the date they are passed. Such records have to be kept at a company’s registered office and be available for inspection if requested.

Stock transfer form

This is imperative to transfer the shares from the transferor to the company. A company must not register a transfer of shares in the company unless a proper instrument of transfer has been utilised. Once the payment has been made for the shares by the company, the transferor of the shares will need to sign a stock transfer form and pass this on to the company.

Company House filings

You must file special resolutions with Companies House within 15 days of passing them. Where a company fails to comply with this requirement, the company and every officer of it who is in default commits an offence. A person guilty of an offence is liable on summary conviction to a fine and for continued contravention, a daily default fine.

Please note that it is a director’s legal duty not to file false information with Companies House, therefore the information filed must be accurate. It is a criminal offence for a person to knowingly or recklessly file a document or statement with Companies House that is misleading, false or deceptive.

This is particularly important to company directors and is one of the many director’s duties that can be easily forgotten. In 2013, Redditch Magistrates’ Court provided the first-ever successful prosecution in the UK for providing false information to Companies House. Mr Kevin Brewer was subsequently fined £12,000 for the offence.

Check the articles of articles of association and if necessary, amend them

The articles of association are the company’s written rules setting out how the company is governed. Depending on the articles, it may be the case that your articles prohibit the company from buying back shares. If this is the case, the articles will need to be amended to allow a share buyback. In order to amend the articles, a special resolution will need to be passed, which will need to be filed at Companies House within 15 days of passing the resolution.

Check any relevant shareholders’ agreements and if necessary, amend them

The Shareholders’ Agreement (if any) may contain a “buyback” clause. The buyback clause will usually create a right for the continuing shareholders to buy the shares often at a price fixed by a third-party valuer. It could also give the company buyback rights so that in the event of a transfer, the company will have the exclusive right to purchase those shares. The articles and any Shareholders’ Agreements will therefore need to be reviewed to ensure that the buyback is possible.

Failing to carry out the above procedures and documentation in connection with the decision-making amongst directors and shareholders is failure to comply with statutory requirements of the CA 2006. The consequences of this can be far-reaching and dramatic, so it is imperative for each director and shareholder that these requirements are complied with by the company.

Post share buyback

Shares bought back by a private company as part of an off-market purchase:

· May be cancelled or held in treasury if purchased out of distributable profits or from cash; or
· Must be cancelled if purchased from the proceeds of a new issue of shares or from capital.

Where the shares are cancelled, the cancellation takes place immediately upon the return of the shares to the company and the company’s issued share capital is reduced by an amount equal to the nominal value of the shares bought back.

Various forms are required to be filed at Companies House and HMRC when conducting a buyback. In almost all buybacks, stamp duty is payable on the purchase price of the shares at a rate of 0.5%, unless the repurchase price is £1,000 or less.

The company registers must be updated to reflect the cancellation of shares following the buyback or any shares held in treasury by the company. Furthermore, a copy of the buyback contract must be kept available for inspection by shareholders, free of charge, at the company’s registered office for a period of at least ten years beginning with the date that the purchase of all shares under the contract is completed or the date that the contract otherwise determines.

Why the failure to follow the share buyback procedure can have serious consequences

The consequences for failing to strictly comply with the requirements in the CA 2006, which can result in:

– The transaction being treated as unlawful and void (meaning the courts could potentially unravel the buyback transaction and deem that the outgoing shareholder is still the lawful shareholder of the shares); and
– An offence being committed by the company and each of its officers. Please be aware that an officer in default is liable to a prison term of up to two years, and an unlimited fine, or both).

This is compounded by the fact that although many of the provisions of the CA 2006 are quite flexible and, where processes aren’t followed to the letter it is often quite straightforward to ratify things, however, there is no mechanism to ratify a defective share buyback.

An apparently minor failure to follow the CA 2006 requirements to the letter can therefore result in a very messy and often costly situation. The potential problems caused by getting the procedure wrong could result in the company being completely derailed and potentially leaving its directors liable for criminal offences. The only sensible approach is for directors to take legal advice at an early stage.

The process can be a complex transaction and will differ depending on the type of your company. As above-mentioned, there are also numerous requirements under the Companies Act 2006 that must be fulfilled.

Contact our corporate solicitors 

For more information about company share buybacks, contact our corporate legal team.

SO Legal has solicitors in Brighton, Eastbourne, Hastings London and Uckfield, and we work with clients across the UK.