A buyback of shares, also known as a share repurchase, occurs when a company purchases its own shares from the public market. It’s a strategic move for a company to invest in itself, and results in a reduction of the overall number of shares available for trading, which can help shareholder value. This action can boost the portion of shares owned by existing investors. Companies have various motives for doing buybacks. They might want to enhance the value of the remaining shares by limiting the supply, or they might aim to prevent other shareholders from gaining too much control. In this blog, we shall understand what is buyback of shares and other specified securities.
Sources of Buyback of Shares
A company has several sources from which it can purchase its shares or even other specified securities. These sources are defined by specific regulations and guidelines to ensure compliance with corporate laws and they are:
1. Free Reserves
One of the primary sources for a company to conduct a buy-back is its free reserves. These reserves are accumulated profits and earnings that have not been distributed as dividends or utilised for any other purpose. Free reserves provide the financial flexibility required for a buy-back program.
2. Securities Premium Account
The securities premium account is another legitimate source for buy-back activities. This account is typically funded by premiums received from issuing shares at prices exceeding their face value. Using these funds for buy-backs can help companies manage their capital structure.
3. Proceeds of Issued Securities
Companies can also finance buy-backs using the proceeds from the issuance of shares or other specified securities. This provides a circular flow of capital within the organisation and can be a strategic approach to maintaining control over the company’s ownership structure.
It’s important to note that there is a restriction in place to prevent misuse of buy-backs. Companies are prohibited from using the proceeds of some earlier issue of same kind of shares for a buy-back. This safeguard ensures that buy-backs are not used to manipulate the market or unduly benefit existing shareholders.
Methods of Buyback of Shares
When a company decides for buyback of shares, it can do so through various methods, as mentioned below:
1. Proportionate Basis Buyback of Shares
This method entails the company repurchasing its shares from current shareholders in proportion to their existing shareholding. The eligibility of each shareholder to sell back shares is determined by the number of shares they currently hold in the company.
2. Open Market Buyback
Companies may choose to buy back shares from the open market. This involves purchasing shares through stock exchanges like any other investor. Open market buybacks offer flexibility and may be used when the company wants to acquire shares without specific regard to the proportionate ownership of existing shareholders. It allows the company to repurchase shares at prevailing market prices.
3. Buyback of Employee Securities (ESOP and Sweat Equity)
Another method of buyback involves repurchasing securities that were originally issued to employees under Employee Stock Option Plans or as part of sweat equity arrangements. Companies use this method to acquire shares held by employees, aligning with their compensation plans and retaining talent. It helps in controlling the dilution of ownership due to employee equity programs.
Conditions for Buyback of Shares
The essential conditions for buyback of shares are:
1. Authorisation in AOA
The company’s Articles of Association must expressly authorise share buy-backs. In the absence of such a provision, the AOA should be first amended to include the necessary authorisation.
2. Limits of Buy-Back
a) By Board Resolution: The company can buy back shares up to 10% or less of the total paid-up equity capital and free reserves through a Board Resolution.
b) By Special Resolution: Buyback of shares exceeding 10% but up to 25% of the aggregate of paid-up capital (both equity and preference) and free reserves requires approval through a Special Resolution. The explanatory statement for the Special Resolution should include the points specified in Section 68(3) of the Companies Act 2013 and Rule 17(1) of the Companies (Share Capital and Debentures) Rules 2014.
3. Debt-Equity Ratio
The post-buy-back debt-equity ratio of the company cannot exceed 2:1. This provision ensures that the company maintains a healthy balance between debt and equity after the buy-back.
4. Fully Paid-Up Shares
Only fully paid-up shares are eligible to be bought back by the company in a financial year.
5. Cooling Period
No offer of buy-back can be made within one year from date of closure of the preceding offer of buy-back. This cooling-off period prevents frequent and consecutive buy-backs.
6. Completion Period
Every buy-back, whether through a Special Resolution or a Board Resolution, must be completed within one year from the date of passing the resolution.
7. Restriction on Issuing Similar Shares
Following the completion of a buy-back, the company cannot issue the same kind of shares, including right issues, within a period of 6 months, except for bonus issues or the discharge of subsisting obligations like conversion of warrants or stock option schemes, sweat equity, or the conversion of preference shares or debentures.
8. Withdrawal of Offer
Once an offer of buy-back is announced to the shareholders, it cannot be withdrawn. This rule ensures the commitment and fairness of the buy-back process.
9. Basis of Buy-Back Price
The calculation of the buy-back price should be based on either audited accounts not more than 6 months old from the date of the offer document or unaudited accounts not older than 6 months from the offer document, subject to a limited review by the company’s auditor. This ensures that the buy-back price is determined using recent and accurate financial information.
Procedure for Buyback of Shares in Unlisted Companies
The process of for Buyback of Shares in Unlisted Companies is as follows:
1. Convene the Board Meeting
Initiate by arranging a meeting of the Board of Directors to discuss and approve the share buy-back proposal.
2. Passing of Special Resolution
Gain approval through a Special Resolution for the buy-back at a General Meeting. Shareholders should receive a notice along with an explanatory statement, a minimum of 21 days before the meeting.
3. Convene General Meeting or File MGT-14
Alternatively, the Special Resolution can be ratified during a General Meeting. In the absence of this, file Form MGT-14 with the Registrar of Companies within 30 days post the Special Resolution.
4. Letter of Offer (Form SH-8)
Prior to the buy-back, ensure the submission of a Letter of Offer (Form SH-8) with the ROC. Signed by at least two directors, promptly dispatch it to shareholders, not exceeding 20 days from filing with the ROC.
5. Offer Period
Keep the buy-back offer accessible for shareholders for a minimum of 15 days, extending up to 30 days from the Letter of Offer dispatch. Modifications to this timeframe require unanimous agreement from all involved shareholders.
6. Declaration of Solvency (Form SH-9)
The company should file a declaration of solvency in e-Form SH-9 with the ROC, along with the Letter of Offer. This declaration should be signed by at least two directors and verified by an affidavit from the Board of Directors.
7. Acceptance of Offer
If the number of shares offered by shareholders exceeds the total number of shares to be bought back, the acceptance should be on a proportionate basis.
8. Separate Bank Account
After closing the buy-back offer, the company should immediately open a separate bank account and deposit the necessary funds to cover the consideration for the shares tendered for buyback of shares.
9. Verification
The company should complete the verification of the offers received within 15 days from the date of closure of the offer. Shares or securities lodged for buyback of shares should be deemed accepted unless a rejection communication is made within 21 days from the offer’s closure.
10. Payment
Within 7 days from the date of verification of the offers, the company should:
a) Make cash payments to shareholders whose shares have been accepted.
b) Return share certificates to shareholders whose shares are not accepted.
11. Extinguishment of Shares
The company should extinguish and physically destroy the shares bought back within 7 days of completing the buy-back.
12. Return of Buy-Back (Form SH-11)
Submit a Return of Buy-Back in Form SH-11, along with a Compliance Certificate in Form SH-15, signed by two directors (one of whom must be a Managing Director, if any), within 30 days of completing the buy-back.
13. Register of Buy-Back (Form SH-10)
Maintain a register of shares bought back in Form SH-10 at the Registered Office of the Company and keep it in safe custody. This register should be updated to reflect the buy-back transactions.
Final Thoughts
Adherence to the regulatory framework outlined in the Companies Act, 2013 is imperative for companies for buyback of shares. Straying from the stipulated procedures not only invites penalties, with fines ranging from 1 to 3 lakh rupees for companies and their officers, but can also lead to a host of prohibitions on buy-back activities. These prohibitions encompass situations involving subsidiaries, investment companies, and defaults in financial obligations.
However, the Act does provide some flexibility by allowing buyback once defaults are rectified and a cooling-off period has elapsed. To ensure legal compliance and avoid adverse consequences, companies must carefully follow the prescribed steps and maintain their financial obligations, ultimately safeguarding their reputation and financial stability.
