Share Buybacks – Common Pitfalls

A share buyback is the process a company follows to purchase its own shares back from one or more of the company’s current shareholders.

A share buyback process can be utilised by a corporation for a number of purposes, including to:

• Exit a shareholder from the company - This is often considered an efficient way of exiting a shareholder, given that the purchase is typically funded directly from retained profits (rather than out of the taxed profits of the continuing shareholders);
• Return cash to shareholders – This may be to distribute retained profits or the proceeds of sale following the disposal of an asset by the company; 
• Operate an employee incentive scheme -This may be used to purchase and cancel an employee’s shares when they leave the company; or
• Adjust the proportions in which shareholders hold shares – This may be useful where investing shareholders wish to decrease their holding in exchange for realising part of their investment. 

Pitfall 1: Inadequate review of the company’s constitution

Failure to thoroughly review the company’s articles of association and other relevant constitutional documents prior to implementing a share buyback may result in an unintentional violation of restrictions, conditions or specific requirements. 

Before embarking on a share buyback, carefully examine key company documents, including the articles and any shareholders’ agreement, to check whether share buybacks are permitted.

Where they are permitted, there may be limitations or conditions on any buyback or on the particular class of shares for which a buyback is proposed, which should be noted. 

Pitfall 3: Lack of compliance with the requirements for a buyback contract

Except where the buyback of shares is made pursuant to an employees’ share scheme and under the shareholders’ general authority, a company may only make an off-market purchase of its own shares pursuant to a contract that is approved by the members prior to the purchase. 

Whilst the buyback contract is typically a simple agreement providing for the company to repurchase the shares, it is essential that the contract is drafted carefully, including as to how the often-competing interests of the company and the selling shareholder are accounted for and balanced. 

Pitfall 5: Purchase price either left outstanding as a loan account, paid after completion or paid in instalments or on a deferred basis.

It is a legal requirement that any shares bought by a company as part of a share buyback are paid for at the time they are purchased, meaning that it is not possible for the payment to be deferred or paid in instalments. 

Companies must carefully assess their financial position before initiating a share buyback.

Adequate funding should be in place to ensure prompt payment for the repurchased shares. 

Failure to adhere to the statutory procedure when carrying out a share buyback can create significant liabilities for directors and uncertainties, which could jeopardise future transactions.

It is, therefore, prudent to obtain legal advice from experienced solicitors.

Additionally, buybacks are subject to special rules with regard to the tax treatment of the departing shareholder, and it is essential that tax advice is taken as part of the transaction.