BUY BACK OF SHARES

The Author of this blog is Anshika Jindal, Student, School of Law and Legal Affairs, Noida International University, Greater Noida. 

 

 

Introduction

Under section 68¹ of the Companies Act, 2013 read with Section 77A of the Companies Act, 1956, signifies that any company limited by shares or company limited by guarantee having a share capital[2] can buy its own securities, whether it is a public company³, private company ⁴or an unlisted company⁵. The Companies (Amendment) Ordinance (October 31, 1998, and January 7, 1999) have allowed companies to buy back their own shares subject to regulation laid down by SEBI(Buyback of securities Amendment) Regulations,2013 as well as subsequent amendments thereafter. The Ordinance lay down the provisions concerning buyback of shares.

Buyback Of Shares

Buyback of shares refers to the process by which a company re-purchases its shares by buyback of shares and other specified securities from its existing shareholders at a price higher than the market price.

Besides, whenever a company repurchases its shares, the outstanding shares in the market fall. The buyback of shares is governed by Section-68⁶ of the Companies Act, 2013.

Furthermore, it’s a method of the cancellation of share⁷ capital^. The buyback of shares is also referred to as ‘share repurchase’. Generally, they need for buyback arises when the management considers that the shares are undervalued or if the outstanding shares are falling.

 SALIENT PROVISIONS REGARDING BUYBACK OF SHARES:-

The provisions of buyback of shares are mentioned in Section-68⁸ of the Companies Act, 2013-:

1.      Buy back in a financial year shall not exceed 25% of the free reserves an equity of a company.

2.      Buy back would be used only for restructuring of capital and for treasury operations.

3.       Buy back of shares can be done out of the company’s free reserves, share premium account or proceeds of any earlier issue specially made for buyback purpose.

4.      The post-buy debt-equity ratio will be at 2:1.

5.      There will be a 24 month gap between two buybacks of the same type of security. However, there will be no bar on the issuance of other types of securities including that debentures⁹ and preference equity.

6.      Companies desiring to buybacks shares will have to seek following approval from the Board of Directors.

7.      The buy-back process will have to be completed within 12 months from the date of passing the special resolution, authorized by the article of association of company.

8.      Companies, which have defaulted in repayment of deposits, redemption of debentures/ preference shares¹⁰ and repayment to financial institutions will not be allowed the buyback option.

9.      A company seeking buyback will be permitted to do so after making full discloser, of all facts, the need for the buyback, the class of shares to be bought back, the person from whom the buyback is to be effected etc.

10.  ESOPs cannot be issued to promoters or directors holding 10% or more shares.

Objectives Of Buyback Of Shares

There are some main objectives of buybacks of shares are given below:-

1.      Unused cash

2.      Tax Gains

3.      Market Perception

4.      Exit Option

5.      Escape monitoring of accounts and legal controls

Whether A Company Can Buyback Of Its Own Shares Or Not?

Yes, a company can buyback of its own shares from following ways:-

●       From the existing shareholders on a proportionate basis.

●       From the open market.

▪         Book building process

▪         Stock exchange

●       From old lots.

●       By purchasing securities issued to employees of the company pursuant to a scheme of stock option or sweat equality¹¹.

 Reasons For Buyback Of Shares

There are several reasons associated with it that urge a company to announce a buyback:-

1.      UNDERVALUED STOCK- This is one of the main reasons why companies opt to buy back their shares. When the management feels that their stock is undervalued, they adopt the buyback route to rectify the stock price. The stock buyback reduces the number of shares in the market and thus gives a price boost to the remaining shares in the market.

2.      EXCESS CASH WITH NOT MANY PROJECT OPPORTUNITIES- A company with free reserve in hand but not many project opportunities would prefer to go for a buyback. The Company would use the cash to reward the shareholders rather than keeping it idle in the bank account over the require amount.

3.      TAX AFFICIENT METHOD OF REWARDING SHARE HOLDERS- The dividends get tax at two levels. First, at the company level and a second time in the hands of the shareholders. In the case of buy back only the company can liable to pay the buyback tax.

4.      STRENGTHEN PROMOTOR HOLDING IN THE COMPANY- The company promoters can increase its stake in the company by forfeiting the buyback offers. This strengthens their hold over the company and acts as a defense strategy in the case of hostile take overs.

5.      TO ACHIEVE OPTIMUM CAPITAL STRUCTURE- The capital structure of a company gets represented by its debt- equity ratio. Each industry has a different capital structure requirements, some industries may not be suitable to rely on more debts.

In India, the buyback is done only through the extinguishing of shares. In other countries buyback is also done to reward employees. The companies buyback of shares from the public and distributes them to employees as ESOP.

CRR- Capital Redemption Reserve Account

According to Section 69¹² of the Companies Act 2013, where a company can brought back shares out of free reserves or out of the securities premium account, then an amount equal to the nominal value of the shares need to be transfer to the CRR account. Such transfer detail should be disclosed in the balance sheet.

 The CRR may be utilized for paying unissued shares of the company to the members as fully paid bonus shares.

Restriction Of Buyback Of Shares

According to Section 70¹³ of the Companies Act, 2013 a company should not buyback its securities or other specified securities, directly or indirectly-

1.      Through any subsidiary including its own subsidiaries, or

2.      Through investment or group of investment companies, or

3.      When company have defaulted in repayment of deposits or interest payable thereon, or in redemption of debentures¹⁴ or preference shares¹⁵ or repayment of any term loan.

The prohibition is lifted if the default has been remedied and a period of 3 years s elapsed after such default ceased to subsist.

4.      When company has defaulted in filling of annual return, declaration of dividend and financial statement.

Advantages And Disadvantages Of Buybacks Of Shares

ADVANTAGES:-

1.      It might increase confidence in the investor’s on the company’s board of directors as they know directors are ever willing to return surplus cash if it’s not able to earn above the company’s cost of capital.

2.      Buyback helps a company to reduce its excessive share capital that is not required for the time being and help the company to utilize its large sum of free reserves.

3.      Buyback of shares can increase returns on equity. It has a greater effect when more undervalued shares¹⁶ are repurchased. This is the most profitable course of action for the company.

4.      Companies may buy back its own shares as protection against unfriendly takeovers from other companies.

5.      The buyback is considered as the quickest method for reduction of share¹⁷ capital. It involves lower cost transaction.

6.      It acts as an excellent tool for financial re-engineering. In case of profit-making, the companies having high dividend payments, buyback can boost their bottom lines since dividends attract taxes.

DISADVANTAGES:-

1.      The biggest disadvantage of the buyback is that cash which is being used by the company to repurchase securities can be used for another productive purpose like installing the new manufacturing unit, hiring new staff, increasing the market expenditure to boost sales which in return can result in an increase in the profits of the company. But if the company goes for buyback it overlooks all the profitable alternatives which can be used.

2.      The next drawback of the buyback is that sometimes it may give a wrong signal to them about the company so as to increase the price of the stock so that promoters can sell their stocks. Hence, innocent investors get trapped when the news of buyback comes into the market domain as the prices of the stock rise.

3.      It creates a negative image in the market that company is no more profitable as the company uses its excess cash for buyback of stocks. It creates a negative image in the mind of long term investors who are looking for capital appreciation due to growth in the company.

Conclusion

Thus, it can be concluded that Indian companies announce buy back in response to under valuation position of their stocks in capital markets and they are well supported by availability of sufficient cash balance available for the same. Thus, on one hand, premium offered in terms of buy back prices announced offers an exit opportunity for shareholders and on the other hand, it offers an opportunity for the company to use its liquidity position to extinguish its shares today and issue them again in future.

Buy back becomes vital and every shareholder must reconsider all his views before purchasing the shares of companies involved in the process of buy back.

Endnotes

1.       

2.       Ravi Puliani, Companies Act, 2013 1.96-1.98 (Bharat Law House, New Delhi, 33^rdedn, 2020).

3.       Section 2(71) - Companies Act, 2013 ("public company" means a company which- (a) is not a private company;[and] (b) has a minimum paid-up share capital).

4.       Section 2(68) – Companies Act, 2013 ("private company" means a company having a minimum paid-up share capital as may be prescribed, and which by its articles, (i) restricts the right to transfer its shares; (ii) except in case of One Person Company, limits the number of its members to two hundred).

5.       Available at- http://www.companyplanners.com.au/faqs/unlisted.shtml.

6.       Ibid.

7.       Section 2(84) - Companies Act, 2013 ("share" means a share in the share capital of a company and includes stock).

8.       Ibid

9.       Section 30 – Companies Act, 2013 ("debenture" includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not).

10.    Section 43, Explanation (ii) – Companies Act, 2013 (preference share capital, with reference to any company limited by shares, means that part of the issued share capital of the company which carries or would carry a preferential right with respect to).

11.    Section 2(88) – Companies Act, 2013 ( "sweat equity shares" means such equity shares as are issued by a company to its directors or employees at a discount or for consideration, other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called).

12.    Section 69 – Companies Act, 2013 ((1) 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 purchased shall be transferred to the capital redemption reserve account and details of such transfer shall be disclosed in the balance sheet. (2) 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).

13.    Section 70 – Companies Act, 2013 ((1) No company shall directly or indirectly purchase its own shares or other specified securities-(a) through any subsidiary company including its own subsidiary companies (b) through any investment company or group of investment companies; or (c) if a default, is made by the company, in the repayment of deposits accepted either before or after the commencement of this Act, interest payment thereon, redemption of debentures or preference shares or payment of dividend to any shareholder, or repayment of any term loan or interest payable thereon to any financial institution or banking company: Provided that the buy-back is not prohibited, if the default is remedied and a period of three years has lapsed after such default ceased to subsist.(2) No company shall, directly or indirectly, purchase its own shares or other specified securities in case such company has not complied with the provisions of sections 92, 123, 127 and section 129.

14.    Ibid.

15.    Ibid.

16.    Available at – https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/undervalued/.

17.    Ibid.

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