Buy-Back of Shares by a Company

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Introduction

Buy-back is an excellent financial tool.Buy-back of shares relates to the company buying back its previously issued shares from the market. It is nothing but a process by which a company buys-back its shares from the existing shareholder, usually higher than the market price. It means the purchase of its own shares or other securities specified by a company.

Traditionally, subject only to few exceptions as  mentioned under Section 67, companies are  not permitted to purchase their own shares. Section 77-A brought in by the companies (Amendment) Act, 1999, caused this change in the theme and philosophy of Company Law, that subject to the restrictions mentioned in the section, a company may buy-back its own shares. Now this power is given under Section 68 of the Companies Act, 2013. [1]

In a case of buy-back, a company offers to take back its shares owned by the investors at a specified price generally determined or arrived on the basis of the average price of the shares in the past few months. This is done at a premium on the market price to attract a larger number of investors, which may differ as per the financial prudence of the company. Thus, Buy-back is one of the essential modes of capital restructuring.

In no growth situation, buyback option is expected to help to correct equity share capital in the existing capital structure of a low leverage company that earns stable returns.

Buy-back provisions are governed under sections 68, 69 and 70 of the Companies Act, 2013. In line with this, a company can buy-back its own securities. Thus, this falls under the exception as here no confirmation by the court is necessary.  In accordance with this, SEBI also came out with SEBI (Buy-Back of Security) Regulation, 1998 is applicable to listed companies. Also, Rule 17 of Companies (Share Capital & Debenture) Rules, 2014 contains the regulations concerning  buy-back of securities for unlisted companies.

Objectives of buy- back of shares

  1. Cash not used- the company has a huge cash reserve and if the company thinks fit that the market price of its shares  is undervalued, they can buy back shares as reward for their shareholders.
  2. Exit option- the company wants to exit the market from a particular country; if it wants to close, the company can offer to buy-back its shares that are there in the market.
  3. Escape accounting and legal control- the company can avoid the regulation market in the books of accounts.
  4. Tax gains- the companies may prefer to buy-back to reward their investors instead of distributing cash dividends because they relax at a higher rate than the capital gains.
  5. Market perception- by buying back shares from shareholders at a higher price than the prevailing market price indicates that the company share valuation should be higher.

Advantage of Buy-back of shares

  1. Boost up the confidence of the investors on the company board of directors as they know directors are ever willing to return surplus cash if it’s not able to earn above the company cost of capital.
  2. Helps a company to reduce its excessive share capital that is not required for the time being and helps the company to utilize its large sum of free reserves.
  3. Increase return on equity.
  4. Leads to greater effect when more undervalued shares are repurchased. Leads to the most profitable source of action for a company.
  5. Acts as a tool for financial re-engineering. In case of profit making, the companies having high dividends payments, buy back can boost their bottom lines since dividends attract taxes.
  6. Companies may buy their own shares as protection against unfriendly takeovers from other companies.
  7. Considered as the quickest method for reduction of share capital, it involves lower cost transactions.
              Class of companies  Regulation
Buy-back of Unlisted Public company & Private limited CompanySections 68, 69, 70 of the Companies act, 2013 Rule 17 of companies (share capital & debentures) Rule, 2014.
Buy-back for listed companiesSection 68, 69, 70 of Companies Act, 2013 Rule 27 of the companies (share capital & debentures) rule,2014 Security exchange Board of India (Buy-back of securities Amendment) regulation, 2013

Reasons for Buy-back

  • It is an alternative mode of reduction in capital which is without the requirement of  approval from the court/NCLT;
  • To improve the earning per share;
  • To enhance return on capital and , enhances the  return on net worth with the long-term shareholder value;
  • To provide an additional exit route to shareholders when shares are low or  traded not in consideration;
  • To enhance the overall growth of state in the company;
  • To prevent unwelcome takeover bids;
  • To return surplus cash to shareholders;
  • To achieve optimum capital structure;
  • To support share price during fall in market condition;
  • To serve the equity more efficiently.
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Sources of Buy-back

Section 68(1) of the Act provides that companies can buy-back its  shares by  purchasing its own shares and other specified securities out of-

  • Its free reserves;
  • The securities premium account pr;
  • The proceeds of the issue of any or other specified securities.

Moreover, Buy-back of any kind of shares or other securities cannot be made out of the proceeds of earlier issue of same kind of shares or same kind of specified securities.

Conditions for Buy-back:

According to the provision mentioned under section 68(2) of the Companies Act, company’s buy-back of its shares or other specified securities can occur only in the following conditions –

  1. Buy-back should be authorized by its articles;
  2. Under this, a special resolution has to be passed at a general meeting of the company authorizing the buy-back;
  3. In case of listed company, approval of shareholder shall be obtained only by postal ballot;
  4. The buy-back is 10% or less of the total paid-up equity capital and free reserves of the company then a resolution at Board meeting need to be passed;
  5. The overall limit of buy-back is twenty–five percent or less of the total paid-upequity capital and free reserves of the company.
  6. In consideration to the buyback of equity shares in any financial year, the maximum number of shares can be brought back is twenty-five percent with respect to its total paid-up equity capital in the financial year.
  7. The buy-back debt-equity ratio cannot exceed 2:1.
    1. The ratio of the aggregate of secured and unsecured debts should not be more than twice the paid-up Capital and its free reserves.
    1. In line with this, The Central Government is empowered to relax the debt-equity ratio in case of class or classes of companies but not securities for buy-back are fully paid-up.
  8. The shares and securities for buy-back can be only brought up when fully paid up in the financial year.
  9. Buy-back of shares or any other securities listed on any recognized stock exchange is in accordance with the regulations made by the Securities and Exchange Board (SEBI).
  10.  All buy-back is needed to be complete within 12 months from the date of passing the Special Resolution or the Board Resolution as the case may be.
  11.  Under section 68(2) of the Companies Act, 2013, no offer of buy-back shall be made within a period of one year from the date of preceding offer of buy-back.
  12.  In Accordance with section 68(3) of the Companies Act, 2013., he notice of special resolution need to be passes by an explanatory statement stating-
  13. A fully and complete disclosure of all material facts;
  14. The necessity for the buy-back;
  15. The class of security intended to purchase under buy-back;
  16. The amount invested under buy-back;
  17. The time limit for completion of buy-back.

Also, the company needs to pass a special resolution in its general meeting after the procedure is laid down in section 101 & 102.

  1. Section 68(4) of the Companies Act, 2013 states that the time limit for completion of buy-back that is required to be completed within one year from the date of passing the special resolution or by the Board Resolution.

Modes of Buy-back

According to the provision mentioned under Section 68(5) of the Companies Act, 2013,  a company may buy-back its shares or any other securities by any of following method-

  1. From the existing shareholders or through security holders on a daily basis;
  2. From the open market through the Book-Building process or Stock Exchange.

Also, it is provided that buy-back for 15% or more can be made through the open market.

  1. From purchasing the securities issues to the employees of the company pursuant to a scheme of sweat equity or stock option.

Important Provisions

  • The company which has been authorized by a special resolution l before the buyback of shares a file with the registrar of companies. Also, a letter of offer in form no. 8 along with the fees mentioned.
  • Such a letter of offer shall be dated in consideration to the board of directors of the company by at least two directors of the company one of them should be the managing director.
  • Under section 68(6), a declaration of solvency is required to be filed by the company with registrar in the prescribed form SH-9 signed by at least two directors of the company one of whom shall be managing director, if any ,and verified by an affidavit before the buy-back is implemented to guarantee its solvency for at least a year after the completion of buy-back.
  • Under section 68(7) with a company after the completion buy-back is required to destroy its securities within 7 days of the last day on which the buy-back process is to be completed.
  • A company buying back its securities is prohibited from making further issue of securities within 6 months. However, it can make a bonus issue and discharge its existing obligations defined under section 68(8).
  • A company is required to maintain a register form SH-10 containing the particular of the bought back securities, including consideration paid for them and the date of cancellation of shares and securities with the date of extinguishing and physically destroying the share and securities and any other particular may be prescribed.In accordance with section 68(9) such particulars are required to be entered in the register of buy-back securities within 7 days of the date of completion of buy-back.
  • In line with section 68(10), with after such completion of the buy-back process, the company shall within 30 days file with SEBI and the registrar a return in the form no. SH-11 along with the fees and a certificate in Form No. Sh.15 should be signed by two directors of the company and also, the managing director. A company whose shares are not listed on a recognized stock exchange should file the return of buy-back with the registrar only.
  • If the company makes any default in complying with the provisions it is a punishable offence with a fine which shall not be less than one lakh rupees but which may lead to three lakh, and the officer of company who is liable for default shall be punishable with imprisonment for term that may extend to three years or fine or with both, under section 68(11).
  • Consideration of financial statements for buy-back normally, and the last audited financial statement will be  taken into consideration for calculating limits under buyback done by a company. However, with the addition of the audited accounts if it is more than six month old, the calculation with reference to it  shall be on the basis of un-audited accounts and not older than six months from the date of the after document which are subjected to review by the auditors of the company.
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Transfer of certain sums to Capital Redemption Reserve Account (CRR)

It is governed by the provision mentioned under section 69 of the Companies Act, 2013. Where a company purchases its own shares out of free reserves or securities premium account, a sum equal to the nominal value of the shares so purchases shall be transferred to the Capital Redemption Reserve Account and details of such transfer shall be disclosed in the balance sheet.

Additionally, the Capital Redemption Reserve Account may be applied by the company in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares.

Restriction under Buy-back

Section 70 of the Companies Act,. The companies are restricted to buy-back its own shares or other specified securities-

  1. Through subsidiary companies including its own subsidiary companies.
  2. Through investment company or group of investment companies or,
  3. If a default is made by the company, in respect to repayment of deposits or interest payment, redemption of debentures or preference share, payment of dividend to any shareholder, repayment of any term loan or interest payable thereon to any financial institution or banking company.
  4. In  case it has not complied with the provision of section 92, 123, 127 and 129 of the Act.

Buyback under Foreign Direct Investments Guidelines

As per this circular, transfer of shares debentures through buy-back or capital reduction falls under Automatic route. Therefore, it is clarified that the FC-TRC is required to file with  RBI for buy-back of security from non-resident shareholders under FDI.

Conclusion

Companies and the capital market can be re-adjusted by buy-back. As buy-backs are a best way to enhance the shareholder wealth, even though there is a higher degree of uncertainty than dividends since the repurchase’s value depends on the future price of the stock. Thus, responding to the undervaluation of their stocks in the capital markets, they are ensured by the availability of sufficient cash. Hence, a premium in relation to repurchase prices can announce offers on exit options for shareholders.

It has been observed by some analysts that buy-back is made at the cost of hard assets and often companies are forced to sell off their hard assets to mobilize funds for share buy–back exercise. In line with this, SEBI has to play a crucial role in the regulation and guiding the buy-back of shares in India. Moreover, it offers the company the opportunity to use its liquidity position to delete its shares today and redeem them in future.

Moreover, it is important that as  an investor, one should know the purpose and the timing of a buyback and also have a look at the overall financial situation of the company. A shareholder must reconsider all the views before purchasing shares of the company which is involved in the process of buyback.


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