Company Share Buyback Rules, Conditions & Effects
Share Buyback: Key Rules and Terms
1. Sources of Buyback
Sources: Free reserves (for example, retained earnings), securities premium account, and proceeds of earlier issues (not of the same kind).
Note: You cannot use proceeds from an equity share issue to buy back equity shares.
2. Authorization in the Articles of Association
The buyback must be authorized by the company’s Articles of Association (AOA). Amend the AOA if buyback is not already permitted.
3. Approval Required
Approval thresholds:
- Up to 10% of paid-up capital and free reserves: board resolution is sufficient.
- More than 10% and up to 25%: special resolution in a general meeting is required.
4. Limitations on Buyback
Maximum limits:
- Maximum 25% of paid-up capital plus free reserves in a financial year.
- For equity shares specifically: maximum 25% of total paid-up equity share capital.
5. Fully Paid-up Shares Only
Only fully paid-up shares are eligible for buyback.
6. Debt-to-Equity Ratio
After the buyback, total debt should not exceed twice the equity (a maximum 2:1 debt-to-equity ratio). Exceptions may apply for some government companies.
Definition: What Is a Buyback?
Buyback of shares means the company repurchases its own shares from its existing shareholders. In simple terms, the company buys back its shares, reducing the total number of shares available in the market. This consolidation of shares can consolidate ownership and improve certain financial metrics.
When a company buys back its shares, it typically uses surplus cash to purchase these shares, often at a premium to the market price, as a way to return value to shareholders.
Merits
- Improves shareholder value: Reducing the number of shares increases earnings per share (EPS), which may improve market perception.
- Efficient use of surplus funds: Allows companies to return surplus cash to shareholders.
- Supports share price: Buybacks can stabilize or boost the share price, especially when shares are undervalued.
- Prevents hostile takeovers: Reducing the number of shares available in the market can make hostile takeovers more difficult.
- Flexibility for the company: Unlike dividends, which can create expectations of regular payouts, buybacks are typically one-time or occasional events.
Demerits
- Reduces available cash: A buyback consumes company funds, which may reduce capacity for future investments.
- Temporary increase in share price: The effect on share price may not be sustainable.
- Impact on debt levels: If buybacks are funded through debt, they can increase the company’s financial risk.
- Possible misuse by management: Companies might use buybacks to manipulate EPS or executive compensation metrics.
Conditions for Buyback
The statutory and practical conditions include:
- Authorization in Articles: The company must be permitted to buy back shares in its Articles of Association.
- Approval:
- If the buyback is up to 10% of paid-up capital plus free reserves → board resolution is sufficient.
- If more than 10% but up to 25% → special resolution in a general meeting is required.
- Limit on buyback: Maximum 25% of paid-up capital and free reserves in a financial year. For equity shares, the cap is 25% of total paid-up equity share capital.
- Fully paid-up shares only: Only fully paid-up shares can be bought back.
- Debt-to-equity ratio: After buyback, total debt should not exceed twice the equity (2:1 ratio).
- Time gap: A company cannot make another buyback offer within one year from the date of the previous buyback.
- Completion: A buyback must be completed within one year from the date of passing the approval resolution.
Additional Notes
Practical implications: Companies often choose buybacks to optimize capital structure, signal confidence to the market, or return excess cash to shareholders. However, stakeholders should weigh the merits against opportunity costs and potential increases in financial leverage.