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An Overview of Share Buybacks: Purpose, Funding, and Impact

A buyback is a term used to describe when a company chooses to purchase its own outstanding shares from the market. The company may do this for a variety of reasons, such as to increase the value of remaining shares, to improve financial ratios such as Earnings per share, or to return surplus cash to shareholders. Companies typically fund buybacks with cash on hand, debt, or by issuing new shares.

There are several potential reasons why a company might choose to buy back its own shares, including:

  1. To return surplus cash to shareholders:
    Some companies may have more cash on hand than they need to fund their operations and growth, so they use buybacks as a way to return that cash to shareholders.
     
  2. To improve the stake of the promoter:
    Company may decide to buy back shares for the purpose of increasing the stake of the promoter or management in the company, which can align the interests of management with those of shareholders.
     
  3. To improve the value of remaining shares:
    By reducing the number of outstanding shares, buybacks can increase the earnings per share (EPS) for remaining shareholders, which can lead to an increase in the stock price.
     
  4. Conversion of public company into private company:
    Company can conduct a buyback to delist the shares from the stock exchange, effectively making the company a private one.
     
  5. Permanent reduction of paid-up share capital:
    One of the features of buyback is that it reduces the total number of shares outstanding, thus company can reduce the paid-up capital by buying back shares. The buyback process does not require court approval, but is typically subject to regulatory approval.

It's important to acknowledge that while repurchases of shares can have positive impacts on a firm's stock value and financial performance indicators, they are not always advantageous. Some individuals argue that repurchases can be utilized to manipulate a company's stock value, or that they redirect resources away from investments in expansion or creativity.

"Do share buybacks always have a positive impact on shareholders? While buybacks can raise the value of remaining shares and boost returns, it's important to evaluate the company's financials and determine if the buyback is indicative of sound or poor management. Additionally, it's crucial to examine how the buyback is financed, to determine if the company is taking on excessive debt or neglecting future investments. Ultimately, the success of a buyback will depend on the particular circumstances of the company and the motivations behind the buyback."

Under Indian Company Law, for a buyback of shares, a company must pass a board resolution and get approval from shareholders by way of a special resolution, which typically requires a higher threshold of approval than a normal resolution.

The Companies Act, 2013 of India permits companies to buy back shares to the extent of 10% of its paid-up share capital and free reserves by passing a board resolution and 25% of its paid-up share capital and free reserves by passing a special resolution.

In a single financial year, a company is allowed to do buyback of shares to the extent of 25% of its total paid-up share capital and free reserves. However, in case of buyback of equity shares, the percentage of buyback is capped to 25% of equity share capital and free reserves.

It is important to keep in mind that buyback is a complicated process and requires compliance with regulations from the Companies Act, 2013 and the Securities and Exchange Board of India (SEBI). Additionally, companies must pass a board resolution and gain approval from shareholders through a special resolution, and are subject to limits on the percentage of shares that can be repurchased.

Also, companies must adhere to guidelines outlined by SEBI for buyback of securities, including appointing a merchant banker, announcing the buyback, making a public announcement, and other disclosures. It is crucial that companies have adequate funds to complete the buyback and enough surplus to continue funding ongoing operations and growth after the buyback.

Under Indian company law, companies can fund a buyback of shares using a few different sources, including:
  1. Free reserve:
    A company's free reserve is the portion of its profits that is not earmarked for any specific purpose, such as reinvestment in the business or payment of dividends. This reserve can be used to fund a buyback of shares.
     
  2. Securities premium:
    Securities premium refers to the amount received by the company from the issue of shares or other securities, in excess of their face value. This amount can also be used by the company to buy back shares, in addition to the free reserves.
     
  3. Proceeds out of earlier issue of different kind of shares or securities:
    The company can use proceeds of the earlier issue of different kind of shares or securities (other than equity shares) to fund buyback of equity shares, subject to conditions outlined in the Companies Act and regulations of the Securities and Exchange Board of India (SEBI).

It's important to note that a company can only use the above-stated sources to fund buyback if it has enough surplus after meeting its ongoing obligations, and has not defaulted in repayment of any debt. Additionally, the company should also be compliant with all other relevant laws and regulations while using any of the above-stated sources of funds to conduct buyback of shares

The authority for a company to buy back its own shares is typically included in its articles of association. The articles of association are a document that sets out a company's internal rules and regulations, including its powers and objectives.

Under Indian company law, a company can conduct buyback of shares only if it is authorized to do so by its articles of association. If the articles of association are silent on the matter, the company must first alter its articles of association to include the buyback provision before proceeding with the buyback.

This can be done by passing a special resolution in the general meeting of the shareholders, as per the provision of the Companies Act, 2013. Once the alteration is made in the Article of association, the company can move forward with buyback. It's important to remember that any alteration in the Article of association should be compliant with the Companies Act, 2013 and other laws and regulations.

When a company wants to pass a special resolution to authorize a buyback of shares, it must inform shareholders by providing them with an explanatory statement. The explanatory statement must include all material facts related to the buyback, such as the necessity of the buyback, the shares or securities to be repurchased, the amount to be invested in the buyback, and the time limit for completion of the buyback.

The purpose of the explanatory statement is to provide shareholders with all the relevant information they need to make an informed decision about whether to approve the buyback.

In addition to special resolution, when a company wants to pass a board resolution, the Directors of the company need to take a decision regarding the price at which the shares are to be bought back, the objective of the buyback, whom the buyback is to be done, and other important aspects related to buyback. The company's board of directors should also take into consideration of the rules and regulations set by the SEBI and the Companies Act, 2013 before taking a decision on buyback resolution.

When a company wants to offer its existing shareholders the option to participate in a buyback, it must issue a letter of offer. This letter must be filed by the company with the Registrar of Companies (ROC) before it is sent to existing shareholders.

The letter of offer is essentially a formal document that outlines the details of the buyback, including the terms and conditions, the price at which shares will be repurchased, the number of shares to be repurchased, and the time frame within which shareholders can participate in the buyback.

As per SEBI regulations, the letter of offer remains valid for a period of 21 days. It is the time provided for the shareholders to exercise the option to sell their shares back to the company.

The company should offer a minimum of 15 days and a maximum of 30 days to the existing shareholders to exercise their option to participate in the buyback. It's important to note that the buyback process must comply with the regulations of the SEBI and other laws as well as should be in accordance to the company act 2013, before issuing the letter of offer

The debt-equity ratio is a financial metric that compares a company's total debt to its total equity. The ratio is used to evaluate a company's financial leverage and is usually expressed as a decimal or a percentage. The optimal debt-equity ratio can vary depending on the industry and the company, but a general rule of thumb is that it should not be higher than 2:1.

With respect to buyback, the company should ensure that after the buyback, the debt-equity ratio does not exceed 2:1, as per the regulations of SEBI and as well as the provisions of the Companies Act, 2013. The ratio refers to the total debt which includes both secured and unsecured debts, and equity.

It's important to keep in mind that a higher debt-equity ratio can indicate that a company is taking on more debt than it can handle and could be a red flag for investors. Companies that have a debt-equity ratio higher than 2:1 may be considered more risky to invest in, as they could have trouble servicing their debt in the event of a downturn in their business. Therefore, company should be considerate enough that post buyback debt equity ratio should not cross the threshold of 2:1, while deciding on buyback strategy

In addition to the regulations outlined previously, there are several other conditions that a company must comply with when conducting a buyback of shares:

  • All shares or securities to be repurchased must be fully paid up.
  • The company should complete the buyback within a period of 1 year.
  • Company should file a declaration of solvency to the Registrar of Companies (ROC) and Securities and Exchange Board of India (SEBI) before conducting buyback, if the company is listed, the board of directors should also declare that the company will not become insolvent within one year from the date of the declaration.
  • The gap between two buybacks should be at least one year.
  • All shares or securities repurchased must be destroyed within seven days of the completion of the buyback.
  • There is a cooling period of up to 6 months during which the company should not offer further shares through a public issue or right issue, however the company can do bonus, conversion of warrants, stock option schemes, sweat equity, or conversion of preference shares or debentures into shares
  • The company should maintain a register of buyback.
  • The company should file a buyback return within 30 days of completion of buyback with the ROC and SEBI (if a listed company).

If a company contravenes any of the provisions regarding buyback, the company may be liable for penalties ranging from a minimum of 1 lakh to a maximum of 3 lakh.

Officers of the company who are in default may be subject to punishment of up to three years or penalties ranging from 1 lakh to 3 lakh, or both.

If a company uses its free reserve to fund a buyback of shares, it must transfer an equal amount to its Capital Redemption Reserve (CRR) account. The Capital Redemption Reserve is a reserve created by the company by allocating a portion of its profits for the purpose of redemption of capital.

The transfer to the CRR is done to ensure that the company has enough capital to meet its obligations in case of redemption of shares in future. In case of buyback, the amount is transferred to CRR to offset the reduction in the paid-up capital as a result of the buyback.

The funds held in the CRR can be used by the company for the allotment of bonus shares, but they cannot be used for any other purpose. It's worth noting that company can use CRR for the buyback of shares or for redemption of preference shares or debentures in case of redemption of those securities but the transfer to CRR should be done before that

It's important to keep in mind that the rules for CRR can vary depending on the country, so it's important to consult with experts and verify with relevant laws and regulations in India

Under Indian law, there are certain circumstances in which a company is prohibited from buying back its own shares. These include:
  1. When the buyback is done through a subsidiary company, including its own subsidiary company.
  2. When the buyback is done through an investment company or a group of investment companies.
  3. When the company has made a default in repayment of deposits or has failed to repay past dividends. Even if the company has fulfilled the default, it will be prohibited from conducting buyback for a period of 3 years from the date of fulfillment of default.
  4. When the company has failed to comply with certain provisions of the Companies Act, 2013 such as Annual return sec 92, declaration of dividend (section 123), failure to pay dividend on time (section 127), or default in financial statement.

Conclusion
It's important to note that these are some of the examples and there may be other prohibition for buyback as per company act 2013, other laws and regulations. It's important for companies to comply with all laws and regulations to avoid contravening any provisions and facing penalties or other legal action.

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