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Buy Back Of Shares

Meaning
Buy Back of Shares refers to the process by which a company re-purchase its shares and other specified securities from its existing shareholders at a price higher than the market price. It is a way of returning money to its investors. Buy-Back of its own shares by a company is nothing but reduction of share capital. Generally, the need for buyback arises when the management considers that the shares are undervalued or if the outstanding shares are falling.

Sources Of Buyback

Pursuant to section 68 (1) of Companies Act, 2013, a company whether public or private, may purchase its own shares or other specified securities out of following sources:
  • Its free reserves
  • The securities premium account
  • The proceeds of the issue of any shares or other specified securities.
However, buy-back of any kind of shares or other specified securities shall not be made out of the proceeds of an earlier issue of the same kind of shares or other specified securities.
Specified Securities includes employees stock option or other securities as may be notified by the Central Government from time to time.

Conditions Of Buy Back Of Shares

  1. Buy back of shares must be authorized by its articles
  2. A special resolution passed at general meeting is needed to authorize buy-back. However, If buy-back is upto 10% of the total paid up equity capital and free reserves, the Board of directors by passing a resolution at its meeting may authorize the company For such buy-back (only one such buy-back can be done in a year).
  3. Buy-back should not be more than 25% of the total paid up capital and free reserves of The company.
  4. Buy-back of equity shares in any financial year must not exceed 25% of its paid up Equity capital.
  5. Debt-equity ratio should not fall below 2:1 after buy-back.
  6. The shares and the specified securities should be fully paid up.
  7. Company must follow the SEBI guidelines in case of listed shares and prescribed Guidelines in case of others.
  8. Only one buy-back in a year is allowed.
  9. Shares must be physically destroyed within 7 days of completion of buy-back.
  10. No fresh issue is allowed within 6 months from buy-back, except by way of issue of Bonus shares, ESOPs, sweat equity and conversion of debt/preference shares into equity.

Objectives Of Buy Back Of Shares

  1. To increase the promoters holding as the shares which are bought are cancelled
  2. To increase EPS, if there is no dilution in companies earnings as the buy-back reduces the outstanding number of shares.
  3. To support the share price when the share price, in the opinion of the management is less than its fair value.
  4. To pay surplus cash to the shareholders when the company does not need it for the business. For e.g. TCS, Infosys, Wipro, HCL and Tech Mahindra are regularly conducting such programmes since 2014 as part of their capital allocation policies.
  5. To reward shareholders by Buy-back of shares at much higher price than ruling market price.
  6. It safeguard against a hostile takeover by increasing promoters holding.

Procedure For Buy Back Of Shares

  1. Notice of the meeting to be accompanied by the explanatory statement- Notice must include the details regarding all the materials facts, the necessity of the buy back, class of the securities intended to be bought back, amount to be invested under the buy back and the time limit for the completion of the buy back
  2. Declaration of solvency- Before making the buy-back, the company is required to file with the registrar and SEBI a declaration of solvency in prescribed form and an affidavit declaring that it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year of the date of declaration adopted by the board.
  3. Completion of Buy-back- Every buy-back must be completed within 12 months from the date of passing the special resolution or the resolution passed by the board.
  4. Extinguishment of securities- The Company must extinguish and physically destroy the securities bought back within 7 days of the last date of completion of buy-back.
  5. Register of bought back of securities is to be maintained by the company.
  6. Filling of return to be made with the registrar and SEBI (in case of listed company) within 30 days of such completion.


Advantages Of Buy Back Of Shares

  • Buyback of shares might increase the confidence of the investors on the company’s board of directors (BOD) as they know directors are always willing to return surplus cash if it is not able to earn above the company’s cost of capital
  • Buyback assists a company in reducing its excessive share capital that is not needed for the time being and also helps the company to make use of its large sum of free reserves.
  • Buyback of shares can lead to an increment in the returns on equity. It has a greater effect when a greater number of undervalued shares are repurchased. This is the most profitable passage of action for the company.
  • Companies may buy back their own shares for providing protection against the unfriendly takeovers from other companies.
  • The buyback is recognised as the quickest way for the reduction of share capital. It involves a lower cost transaction.
  • It acts as an outstanding tool for financial re-engineering. In the case of profit-making, the companies having high-dividend payments, buy back can upgrade their bottom lines since the dividends attract taxes.

Disadvantages Of Buy Back Of Shares

  • The biggest disadvantage of the buyback is that cash which is being used by the company to repurchase securities can be used for another productive purpose like installing the new manufacturing unit, hiring new staff, increasing the market expenditure to boost sales which in return can result in an increase in the profits of the company. But if the company goes for buyback it overlooks all the profitable alternatives which can be used.
     
  • The next drawback of the buyback is that sometimes it may give a wrong signal to them about the company so as to increase the price of the stock so that promoters can sell their stocks. Hence innocent investors get trapped when the news of buyback comes into the market domain as the prices of the stock rise.
     
  • It creates a negative image in the market that company is no more profitable as the company uses its excess cash for buyback of stocks. It creates a negative image in the mind of long-term investors who are looking for capital appreciation due to growth of the company.

Conclusion
The process of buyback of shares is an effective way for the management to boost up the company’s undervalued share price and reduction in share capital. Further, this process requires the management to show confidence in their business operations and affairs. Furthermore, it is not obligatory that every buyback must automatically benefit the shareholders. It is significant to note that being an investor one should scale the purpose and the timing of a buyback and must also have a look at the overall financial situation of the concerned company. Lastly, a shareholder must reconsider all his views prior to purchasing shares of that company which is indulged in the process of a buyback.

Written By: Nirbhay Saxena - Noida International University

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