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Share Buybacks – Beware the Pitfalls!

5th October 2018

Share Buybacks – Beware the Pitfalls!

Sometimes, a company might want to buy back its own shares, but there are a number of rules to be aware of and steps to follow to ensure that it is done correctly. This note considers some of key points for share buybacks by private companies under the Companies Act 2006.

Why might a company want to buy back its own shares?

  • To buy out shareholders seeking to exit;
  • To return surplus cash to shareholders;
  • To improve earnings per share ratio; or
  • Where an employee shareholder leaves the company.

Methods of finance

The most common ways in which a company will fund the purchase of its own shares are:

  • out of profits available for distribution;
  • out of cash under the de minimis exemption in section 692(1ZA) of the Companies Act 2006 – up to the lower of £15,000 or 5% of the issued share capital in each financial year; or
  • out of capital under Chapter 5 of Part 18 of the Companies Act 2006.

Each method of funding above has its own set of procedural steps to follow, but it is not our intention to run through those steps in this update.

There’s no running away from Tax

A buyback is generally divided into a capital element and a distribution element for tax purposes. Generally speaking the capital element represents the amount subscribed for the share (broadly the nominal value and any premium paid) and anything received in excess of that is treated as a distribution unless (for unquoted companies) it can be given capital treatment for tax purposes. Generally, capital treatment is preferred for most shareholders although individual circumstances will no doubt vary.

There are specific conditions which must be satisfied for capital treatment to apply to the buyback and so it is always advisable for a shareholder to seek appropriate tax advice first. It may also be advisable to obtain prior clearance from HMRC.

Things you need to consider first

  • Articles of Association: If the articles contain a restriction or prohibition against buybacks it will not be permitted. If there is such a restriction or prohibition, consider amending the articles to remove it. There must be express permission in the articles if you intend to use the de minimis exemption.
  •  Pre-emption rights: If there are any pre-emption rights in the company’s articles or any shareholders agreement they will need to be complied with or alternatively waived. Otherwise, pre-emption rights can be amended or removed prior to the buyback taking place.
  •  Share buyback contract: The purchase of a company’s own shares is subject to a contract between the company and the shareholder/s whose shares are to be bought. As a minimum this should set out the main terms of the buyback, including the name of the selling shareholder(s), the number/class of shares being sold and the price to be paid.
  •  Number of shares and paid up status: A limited company can only buy back shares that are fully paid. At least one non-redeemable share must remain in issue after the buyback has taken place.
  •  Approval: A share buyback must be approved by the company’s members. This can be by written resolution or a resolution in a general meeting. A member holding shares being acquired is not an eligible member and cannot vote on the resolution relating to their share buyback.

Payment for shares – don’t mess it up!

An important issue to consider is how the shares are to be purchased. Statute requires any shares bought by a company as part of a share buyback to be paid for at the time they are purchased.

This principle of “cash on completion” means that it is not possible for the payment to be deferred or paid in instalments. You must also be careful about what constitutes “cash” for payment purposes. It may not be what you think it is.

Multiple Buy-backs

If you can’t pay for the shares in one go on completion then it is possible for a buyback contract to provide for a number of buybacks in stages or tranches.

If the buyback is funded out of distributable profits, then the company must have sufficient distributable profits to pay for each individual tranche of shares at the time of each buyback.

Cancel shares or hold in Treasury?

 Shares the subject of a buy-back can be cancelled or held in treasury. Treasury is a “share storage” where the shares are held by the company itself (the company needs to be registered as the holder of the treasury shares). Those shares can be transferred or sold by the company at a later date rather than being cancelled. Holding shares in treasury is only possible if the buyback has been done out of distributable profits.

The company holds the treasury shares but cannot exercise voting rights and is not entitled to any dividends or capital distributions, if any are made by the company. Shares held in treasury can be cancelled at any time.

The company may transfer the treasury shares at any time for cash consideration unless the transfer is pursuant to an employee share scheme, in which case consideration is not required. Any treasury shares sold this way are treated, for tax purposes, as if they were freshly issued shares and generally therefore don’t attract stamp duty on the initial resale.

Stamp duty treatment on the buyback is the same for shares held in treasury as it is with shares which are subsequently cancelled.

 Consequences of non-compliance

A company purchasing its own shares must comply with Part 18 of the Companies Act 2006. Failure to do so will result in the acquisition being void and will also lead to an offence being committed by the company and every officer in default.

If the buyback is void then the shares remain in issue as being owned by the “selling shareholder”. This could lead to bigger issues for the company in terms of future actions taken without considering this shareholder, who remains a member. Dividends and company decision making could be tainted as well as a future company sale process.

Getting it wrong could be disastrous!

 Don’t forget the filings, statutory books and of course any stamp duty!

 Following the buyback you should attend to the payment of any relevant stamp duty, the relevant filings at Companies House and the updating of the company’s statutory books, including any required changes to the PSC register (Persons with significant control).

Ensuring you comply with the statutory requirements of a buyback will allow you to move forward in the full knowledge that there is no comeback on the company or its directors and will enable you to draw a line under the process. The last thing the company will want is to have to incur the time and expense of unravelling a void transaction!

For further advice on any of the issues raised in this article please contact Mark Tromans on 01543 431920 or email mtromans@ansonssolicitors.com