A share buyback is the process a company follows to purchase its own shares back from one or more of the company’s current shareholders.
A share buyback process can be utilised by a corporation for a number of purposes, including to:
The Companies Act 2006 (the Act) sets out the specific and strict procedure for a company purchasing its own shares.
Where this is not followed, the transaction risks being void, and, in addition, an offence may be committed by the company and every officer in default.
A defective buyback means that, even where the selling shareholder receives payment, the shares may not be cancelled and remain an asset of the shareholder, which can create significant legal and tax issues.
It is, therefore, very important that, when dealing with a share buyback, the company takes appropriate advice (both legal and accounting) to ensure it gets it right.
Below, we explore some of the common mistakes made at each stage, from pre- to post-buyback considerations and give tips to mitigate them.
Pitfall 1: Inadequate review of the company’s constitution
Failure to thoroughly review the company’s articles of association and other relevant constitutional documents prior to implementing a share buyback may result in an unintentional violation of restrictions, conditions or specific requirements.
Before embarking on a share buyback, carefully examine key company documents, including the articles and any shareholders’ agreement, to check whether share buybacks are permitted.
Where they are permitted, there may be limitations or conditions on any buyback or on the particular class of shares for which a buyback is proposed, which should be noted.
Pitfall 2: Insufficient funding or reserves
The most common ways for a company to fund a share buyback are as follows:
It is important to conduct a thorough analysis of the company’s available funds and consider alternative financing options.
Each funding method has certain procedural steps which should be adhered to.
Pitfall 3: Lack of compliance with the requirements for a buyback contract
Except where the buyback of shares is made pursuant to an employees’ share scheme and under the shareholders’ general authority, a company may only make an off-market purchase of its own shares pursuant to a contract that is approved by the members prior to the purchase.
Whilst the buyback contract is typically a simple agreement providing for the company to repurchase the shares, it is essential that the contract is drafted carefully, including as to how the often-competing interests of the company and the selling shareholder are accounted for and balanced.
Pitfall 4: Failure to obtain the requisite approvals
In the absence of a provision in the company’s articles or any shareholders’ agreement requiring a higher level of approval, the default position is that a buyback contract must be approved by a simple majority of the company’s shareholders.
Transparency around the rationale, the benefits and the risks of the proposed buyback will prove pivotal in gaining the support of shareholders.
Pitfall 5: Purchase price either left outstanding as a loan account, paid after completion or paid in instalments or on a deferred basis.
It is a legal requirement that any shares bought by a company as part of a share buyback are paid for at the time they are purchased, meaning that it is not possible for the payment to be deferred or paid in instalments.
Companies must carefully assess their financial position before initiating a share buyback.
Adequate funding should be in place to ensure prompt payment for the repurchased shares.
Pitfall 6: non-compliance with post-buyback requirements
Any shares bought back by a private limited company as part of an off-market purchase:
Once the buyback has been completed, companies should promptly complete the following steps:
Failure to adhere to the statutory procedure when carrying out a share buyback can create significant liabilities for directors and uncertainties, which could jeopardise future transactions.
It is, therefore, prudent to obtain legal advice from experienced solicitors.
Additionally, buybacks are subject to special rules with regard to the tax treatment of the departing shareholder, and it is essential that tax advice is taken as part of the transaction.
Our team of expert corporate law solicitors are on hand to assist you if you are contemplating a buyback of shares or if you have recently carried out a buyback that you are concerned may be invalid and require our help to rectify.
