Share buybacks

While share buybacks are commercially desirable, corporate lawyer Jaan Larner explains how they require careful planning and advice to execute effectively and validly.

Corporate and commercial lawyer Jaan Larner outlines the key considerations regarding share buybacks for private companies as provided for by the Companies Act 2006.

There are two main reasons for a private company to initiate a share buyback. First, a company may have surplus cash as a result of outstanding or unexpected profitability, the sale of a subsidiary business, or having cash made available for potential expenditure which has not occurred for some reason. Since it is not efficient for a company to have excess cash without any planned use, shareholders are likely to want surplus cash to be returned to them. Whether a share buyback is the best method for returning cash to shareholders may well depend on the tax considerations of the company and shareholders.

Alternatively, a buyback can be used to allow the exit of a shareholder from a company, especially in the circumstances where the shareholder wishes to exit or a shareholding employee ceases to be employed.

If a private company has a small number of shareholders and one wishes to exit, there may already be provisions in the company’s articles, or ones can be introduced, preventing the shareholder from selling his interest to an unknown or undesirable third party (at least at first). Provisions may also specify that if the remaining shareholders do not purchase the shares from the exiting party the company can repurchase the shares. This way, a third party does not gain an interest in the company and the remaining shareholders do not have to find the funds to pay any money directly to the exiting member.

Articles

Previously, under the Companies Act 1985, the company articles had to specify that buybacks were allowed. Now, under the Companies Act 2006 buybacks are permitted unless the articles specifically prohibit them. Even where this is the case, it should be possible to amend the articles by special resolution.

Since 1 October 2008, although a private company is no longer restricted from giving financial assistance for the acquisition of its shares, it would be advisable to remove any prohibition in a company’s articles before it carries out a share buyback.

Pre-emption provisions or any similar restrictions on transfers of shares may require shares to be offered to existing members before they can be transferred to any other party, including the company. If triggered, these provisions would need to be complied with or amended before the company undertakes a share buyback.

The Buyback Regulations 2013 introduced the ability for a private company to finance a small buyback out of cash, without the payment having to be identified as being made from distributable profits (which was previously required under the Companies Act 2006). However, the company must be specifically authorised to do so in its articles.

Financing

A buyback for a private company can be financed from:

• distributable profits;
• proceeds of a fresh issue of shares made for this purpose;
• capital; or
• cash up to the value in any financial year of the lower of £15,000 or five per cent of its share capital.

Share buyback contract

In order to make a share buyback, a company must do so pursuant to a contract approved in advance. The contract is between the company and the shareholder whose shares are to be purchased, however it need not be a stand-alone contract and can be incorporated into the articles as a power to effect a buyback. While a stock transfer form may not actually be necessary, it is generally good form to include one if only as a receipt.

Directors’ statement and auditors report

Where a company intends to finance a share buyback out of capital, other than for the purposes of an employee share scheme, the directors need to make a directors’ statement. This must:

• specify the amount of the permissible capital payment for the shares in question;
• state that, having made full inquiry into the affairs and prospects of the company, the directors have formed the opinion:

• regarding the company’s initial situation immediately following the date on which the payment out of capital is proposed to be made, that there will be no grounds on which the company could then be found unable to pay its debts. In forming this opinion, the directors must take into account all of the company’s liabilities, including any contingent or prospective liabilities; and
• regarding the company’s prospects for the year immediately following that date, that having regard to both the directors’ intentions with respect to the management of the company’s business during that year, and the amount and character of the financial resources that will, in their view, be available to the company during that year, the company will be able to continue to carry on business as a going concern (and will accordingly be able to pay its debts as they fall due) throughout that year;
• have annexed to it an auditor’s report addressed to the directors.

Among other requirements, the directors’ statement must be in writing and be signed by each of the company’s directors.

The auditor’s report must state that the auditor has enquired into the company’s state of affairs, and that:

• the amount specified in the directors’ statement as the permissible capital payment for the shares in question is, in his view, properly determined in accordance with the Companies ACT 2006; and
• he is not aware of anything to indicate that the opinion expressed by the directors in their statement, about the company’s ability to pay its debts following the date on which the payment out of capital is proposed to be made and its ability to carry on business as a going concern for the year immediately following the date on which the payment out of capital is proposed to be made, is unreasonable in all the circumstances.

Post buyback

Once the buyback has been completed the following steps need to be followed:

• the shares need to be cancelled;
• the relevant filing requirements need to be met and the company records updated;
• the company accountant will have to consider the relevant accounting treatment; and
• stamp duty will need to be paid at the relevant level.

Conclusion

While desirable commercially and simpler than under the previous Companies Act regime, share buybacks still require careful planning and advice to execute effectively and validly.