The share buyback trap: Avoiding common mistakes

Share buybacks, or purchases of own shares, are highly regulated. It is important for companies to comply with Part 18 of the Companies Act 2006 to avoid the common pitfalls that can result in the buyback becoming void, or an offence being committed by the company and its officers.

What is a share buyback?

A share buyback may be exercised to:

• Facilitate the exit of a shareholder;
• adjust share distributions;
• allow the exit of an employee who held shares as an incentive;
• provide shareholders with surplus cash as the value of their shares is realised; or
• increase earnings per share.

Share buybacks involve the company in which the shares are held purchasing its own shares, rather than them being purchased by a shareholder or external buyer, as would be the case with a share purchase. A share buyback results in a reduction in the number of shares and the company’s share capital, whereas a share purchase will leave the company’s share capital unchanged.

Key considerations

Before proceeding with a share buyback, it is important to consider whether there are any express restrictions on share buybacks within the company’s articles of association (“Articles”), or shareholder agreements. Where the company’s Articles and any shareholder agreement are silent, a buyback contract must be approved by an ordinary resolution of the shareholders. Disclosure of the benefits and risks of the proposed buyback will be necessary in the approval process.

A private limited company will purchase its own shares on the basis of an off-market purchase, and this is governed by section 694 of the Companies Act 2006.

Unless the buyback will fall within the de minimis exemption, as outlined in section 692(1ZA) of the Companies Act 2006, a buyback must be financed by distributable reserves, the proceeds of newly issued shares or out of capital. Each of the three options has specific requirements and steps that must be followed, the most stringent of which apply where a buyback is to be financed out of capital.

The purchase price must be paid at the time of purchase. A share buyback can be prepared in a multi-staged process and have completion occur in tranches, as opposed to a shareholder selling the entirety of their intended sale shares in one transaction. This method allows for distributable reserves to accrue but it is important to note that this is different to paying in instalments, which is not permitted.

Upon completion of the buyback, the shares must be cancelled or, if financed out of distributable reserves, they may be held in treasury.

Common mistakes

Failure to comply with the relevant requirements of the Companies Act 2006 may result in the buyback being void. It can also lead to criminal penalties for the company and its officers, such as a prison sentence and/or an unlimited fine.

The most common reasons for share buybacks being void are:

• The company’s Articles not permitting a buyback;
• the company lacking sufficient distributable reserves to fund the buyback; or
• the purchase price being: paid in instalments, paid after completion; or left outstanding on loan account.

Rectifying the mistake

If you have suffered one of the above pitfalls, this can be remedied. It is crucial to consider the tax implications of the rectification method and we would advise seeking bespoke tax advice.

If you require any advice or wish to use our services for a share buyback, please contact our Corporate Team by phone on 0113 207 0000.