Buy-Back of shares also known as Share Repurchase is a strategy adopted by the Corporate Bodies generally to restructure their Capital. Buy-Back of shares happens when a company buys its own shares from the Market. This practice is done for a number of reasons ( such as for reduction of capital, preventing other shareholders from taking a controlling stake, to present itself in the market as financially stable and attractive, etc.) which will be discussed in detail later in the article.
With the rising of the Secondary Market ( i.e. share market) in Indian financial market, it becomes a common strategy adopted by Companies as there are a lot of direct and indirect positive factors involved which contribute to the success of the company. Section 68, 69 & 70 of the Companies Act, 2013, Rule 17 of Companies ( Share Capital and Debentures ) Rules, 2014, Securities and Exchange Board of India (Buy-back of Securities) Regulations, 1998 and Securities and Exchange Board of India (Buy-back of Securities) (Amendment) Regulations, 2018.
Buy-back of shares also known as Shares Repurchase is a power used by the companies by virtue of Section 68 of Companies Act, 2013 allowing the company to purchase its own shares. Buy-back occurs when a company pays the price above the market price of the shares to the shareholders to retain the ownership which they gave it to the public and private investors.
The shares of the company can be repurchased from the open market or from the employees who have been allotted such shares either in the form of Sweat Equity or as Employee Stock Ownership Plans ( ESOPs ) or from the existing shareholders. Both listed as well as unlisted companies can repurchase their shares.
Compared to developed nations, Buy-back of shares is a relatively new concept in India. Originally there was no provision for buy back under Companies Act, 1956 but came under the Act only in 1999 by the Insertion of Section 77A through Companies (Amendment) Act, 1999. This paves the path for the Indian Companies to restructure their capital requirements through a totally different medium. Little did the government know that this medium would be a significant part of Business Corporate Strategy.
Buy-back of shares allows the companies to invest in themselves through purchasing of their own shares. There comes a lot of circumstances where the company feels that their shares in the market are undervalued and purchase the shares with an intention of listing it out again whenever there will be an increase in the price.
Compensation to Employees and Management in the form of stock is also one more reason behind buying back of shares. Companies prefer to compensate their employees in the form of stock as it helps to avoid dilution of existing shareholders. Nowadays, many companies for returning cash to shareholders prefer share buy-backs over dividend as the latter is taxed at a higher rate than the former.
There are various other reasons which are responsible for buy-backs of shares in the corporate sector :
- To utilise the Unused Cash
- To improve Earning per Share ( EPS )
- To give confidence to the Shareholders at the time of falling price
- Reducing the chances of takeover by increasing the promoters shareholding
- To restructure the capital requirements of the Company
- To return surplus cash to the Shareholder
- Tax advantages
Each company in the financial market sometimes faces a period wherein at a certain point there might be no possible future growth for the company or the growth would be too slow. Many factors are responsible for that viz., financial conditions in the market, policies of the company, goals formulated by the company, etc. During this phase, the company’s cash reserves started getting piled up and then there came a situation where the cash reserves became huge with no future plans of investing it.
Unused cash reserves attract shareholders to get themselves paid higher returns on their investments in the form of dividends (which is the cost of equity), which is not a viable option for the companies as the companies unnecessary have to pay for the cash they aren’t using. 1
Hence, in order to tackle the situation like this, usually companies buy back some of it shares from the market at a higher price than the market price which has a twofold benefits: it leads to reduction of the capital of the company and pays off shareholders for their return on the investments in the form of cash.
Another major reason for buy-back of shares is when companies are of the view that their market price of shares is undervalued because of the number of reasons like the recession in the market or the companies performance, etc. The company hence invests in themselves and buys-back its shares from the market at this undervalued price with an optimistic view that the shares will be re-issued once the market price of their shares increases.
Though this is a very risky measure adopted by the companies as there might be a situation that the prices of shares won’t rise, yet the companies adopt this measure, especially companies which have long term need of capital financing, as it increases their equity without diluting company ownership.
There is also a positive side of the buy-back of shares. Investors get attracted towards companies which are buying back their shares because it increases the Earning Per Share ( referred as “EPS” ) of the company and also it shows that the company is financially stable as it has cash reserves for repurchasing their own shares.
EPS ratio is boosted due to buy back of shares as the number of outstanding shares gets decreased because the annual earnings are now divided by a lower number of shares. With the increase of EPS of the company, investors tend to invest in the company which leads to an increase in the market price of the shares.
Reduce Chance of Takeover
Sometimes promoters of the company are under fear of their holding in the company going below a certain level. It can take place due to excessive distribution of shares in the market or any other corporate body buying out majority of shares of the target company with an intention to take over the company.
In order to save the company from such takeover and increase the stakes of the promoters, the company resorts to buying back shares which reduces the chance of takeover and also increases the stake of the promoters. There could be a possibility that it would lead to loss to the companies as there’s a risk factor involved with it.
“A company may buy-back its shares or other specified securities by any one of the following methods:
a) from the existing shares or other specified security-holders on a proportionate basis through the tender offer;
b) from the open market through—
i) book-building process,
ii) stock exchange;
c) from odd-lot holders.”2
- “A company may undertake a buy-back of its own shares or other specified securities out of—
(a) its free reserves;
(b) the securities premium account; or
(c) the proceeds of the issue of any shares or other specified securities.”3
Conditions For Buy Back
According to Rule 4 of SEBI ( Buy-Back of Securities) Regulations, 2018 and Section 68 of the Companies Act, 2013, companies has to fulfil the following conditions for buy-back of shares and other specified securities :
- “The maximum limit of any buy-back shall be twenty-five per cent or less of the aggregate of paid-up capital and free reserves of the company:
- The ratio of the aggregate of secured and unsecured debts owed by the company after buy-back shall not be more than twice the paid-up capital and free reserves.
- No offer of buy-back for fifteen per cent or more of the paid up capital and free reserves of the company shall be made from the open market.”
Restrictions On Buyback
Rule 4 of the of SEBI ( Buy-Back of Securities) Regulations, 2018 and Section 70 of the Companies Act, 2013 contains certain restrictions on the power of the company to buy-back its shares :
- “A company shall not buy-back its shares or other specified securities so as to delist its shares or other specified securities from the stock exchange.
- A company shall not buy-back its shares or other specified securities from any person through negotiated deals, whether on or off the stock exchange or through spot transactions or through any private arrangement.
- A company shall not make any offer of buy-back within a period of one year reckoned from the date of expiry of buyback period of the preceding offer of buy-back, if any.
- No buy-back shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.
- 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 the Companies 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.”
Rule 17 of the Companies (Share Capital and Debentures) Rules, 2014 along with Section 68 of the Companies Act, 2013 states the procedure for the buy-back of shares. Following is the step by step process undertaken by the companies :
1. By virtue of Section 68 (2) of Companies Act, 2013, “company has to take Approval from the Board of Directors and Shareholders in the form of the special resolution passed by them.”
2. The notice of the proposed meeting where such resolution has to be passed be conveyed to shareholders 21 days prior to that meeting with an explanatory statement provided under Section 68(3) of Companies Act, 2013.
3. After the resolution has been passed in the meeting, within 30 days the company has to file MGT-14 form with the Registrar of Companies(ROC).
4. Letter of the offer along with a declaration of solvency has to be filed with ROC and Securities Exchange Board in form SH-8 and SH-9 respectively, which must be signed and verified by at least two directors of the company, one of whom should be the Managing Director of the company.
5. After filing a letter of offer, it has to be dispatched to shareholders within 20 days. Shareholders have to accept the offer within 30 days but not before 15 days from the date of dispatch of the letter of offer.
6. Unless there is a rejection of the offer within 21 days of the closing of the offer, it will be considered as accepted.
7. After the acceptance of the offers by the shareholder, separate bank accounts shall be opened for the shareholders and the due amount is to be deposited in that account.
8. The company shall within seven days of the time specified in point 7-
(i) make payment of consideration in cash to those shareholders or security holders whose securities have been accepted; or4
(ii) return the share certificates to the shareholders or security holders whose securities have not been accepted at all or the balance of securities in case of part acceptance.5
9. Shares and Securities that are being brought back shall be properly accounted for in the register. All particulars mentioned under SH-10 should be incorporated in the register.
10. The company, after the completion of the buy-back, shall file with the Registrar and the Securities and Exchange Board of India, a return in the Form No. SH-11 along with compliance certificate in form SH-15.6
|Increase in Shareholder Value||Overlooks all the profitable alternatives available viz., hiring new staff, installing the new manufacturing unit, etc.|
|Increase confidence in the investors regarding growth of the company||Can creates a negative image in the mind of investors that the company is no more profitable as it uses its cash for buyback of shares.|
|Reduce excessive Share Capital||Higher amount of risk as a secondary market is very dynamic.|
|Increase returns on Equity||Affects Company’s credit rating|
|Protect the company from unwanted takeovers||Benefits short term investors more than long term investors.|
|Provides Exit Opportunity to the Company||Not an Organic growth in Profit as Increase in the EPS,ROA & ROE is not because of the increase in profitability but due to decrease in outstanding shares.|
Buyback of shares has been the most common strategy adopted by Corporate bodies due to its number of benefits which advantages the company as well as the shareholders. But it is not beneficial in the long run as it has a huge risk factor involved with it. Also, it does not depict the real growth of the company because there is not an organic growth in profit of the company as the increase in the EPS ratio us due to the decrease in the denominator i.e. outstanding shares.
Further, buy-backs were beneficial until Budget 2019 came where Government of India came with the 20% tax on the buy-back of shares as many corporate bodies were avoiding giving dividends due to higher rate of tax charged on that and prefer giving cash to shareholders through share buybacks. After Budget 2019, many companies resorted to the traditional form of giving a return to the investment of shareholders i.e. in the form of dividends because the rate of tax on dividends was lower than that of buy-back.
But in the Union Budget 2020, the government got away with the Dividend Distribution Tax ( DDT ) and instead imposed TDS of 10% for above Rs. 5000 of dividend along with the Income Tax paid by the individuals. Now, the promoters, who fall under 30% IT slap, have to pay approximately 43% of tax on the dividends received ( 10% of TDS + 30% of IT + cess ).
Hence, companies are again shifting towards giving cash in the form of shares buyback to the investors rather than dividends. In my opinion, the government should formulate a plan wherein the tax would be almost similar and the company would be free to opt for any method of remunerating the shareholders
- Rule 4(iv) of SEBI ( Buy-Back of Securities) Regulations, 2018
- Section 68(1) of Companies Act, 2013.
- Section 68(7) of Companies Act, 2013.
- Section 68(10) of Companies Act, 2013.
Student, NLIU, Bhopal
Archit Jain is a 4th-year law student at National Law Institute University, Bhopal. He has developed his interest in corporate and commercial laws and is very enthusiastic and keen at making a career out of it. Apart from the corporate, he has an interest in Antitrust/Competition Law as well. For any Clarifications, feedback, and suggestion, you can reach him at email@example.com