Company share buyback overview

Share buybacks represent one of the most frequently used mechanisms for managing share capital and shareholder exits in private companies. The majority of situations where companies repurchase their own shares relate to owner-managed businesses and companies with employee shareholders.

Contact us for advice on your potential share buy back.

Reasons for company repurchase of shares

Commercial drivers include a lack of personal funds to purchase departing members' shares, a cleaner solution than shareholder-to-shareholder transfers and tax treatment can be more favourable than direct share transfers.

In our experience, the majority of share buybacks in private companies occur when employees or directors leave a business and especially where a founding shareholder retires, where employees with shares via a share scheme leave or with family businesses managing generational transition. In summary, with all these situations, a shareholder wishes to exit the company, but no willing external buyer or existing shareholder is available to purchase their shares.

Other reasons for a buyback include :-

• Restructuring or simplifying share capital - to reduce the number of shareholders or consolidate share ownership among key stakeholders.

• Returning surplus cash to shareholders - if the company has accumulated surplus cash and no immediate reinvestment opportunities, a buyback allows the company to return excess capital to shareholders and is an alternative to dividends.

• Resolving shareholder disputes - in situations where there are disputes or irreconcilable differences between shareholders, a buyback can offer a clean exit for one or more parties, preserving the company’s operational stability.

Share buyback rules

The Companies Act 2006 establishes strict conditions for share buybacks, balancing corporate flexibility with creditor and shareholder protection and requiring that :-

• Buybacks must be permitted by company's articles of association

• Shares must be fully paid.

• Payment must come from distributable profits or proceeds of fresh share issue.

• Shareholder approval required (typically by ordinary resolution).

• Contract for purchase must be available for inspection.

• Bought back shares must be cancelled or held in treasury.

• Strict filing requirements with Companies House.

How can a buyback be funded?

A repurchase of shares involves complex, legal, financial and commercial consideration of funding mechanisms as UK law imposes strict rules on how companies can finance the purchase of their own shares. While the default position requires distributable profits, several alternative funding methods exist, each with specific legal requirements and practical implications, including :-

• Distributable profits - the most common and straightforward method relies on the company's distributable profits. The company must have sufficient distributable profits shown in up-to-date accounts, with directors required to confirm ongoing solvency after the buyback completes. This method provides the cleanest approach from a legal perspective but depends entirely on available reserves.

• Fresh issue of shares - companies can fund a buyback using proceeds from a new share issue specifically arranged for this purpose. The new issue must occur in close proximity to the buyback to maintain the connection between the funding and the purchase. This proves particularly useful when the company lacks distributable profits, though it requires willing investors to subscribe for the new shares.

• Capital redemption - this method applies only to shares originally issued as redeemable. The articles must permit redemption, and the redemption price often cannot exceed the original issue price. Companies must establish a specific redemption reserve, making this a more complex option but useful in specific circumstances where shares were structured appropriately from the outset.

• Low value share buyback - private companies can utilise special rules for small buybacks up to £15,000 or 5% of share capital annually without requiring distributable profits. This requires a special shareholder resolution but provides flexibility for smaller transactions, particularly useful for employee share schemes.

• "Back-to-Back" arrangements - when a company lacks immediate funds, a new investor can purchase shares from the departing shareholder, with the company then buying from the new investor when funds become available. This arrangement requires careful structuring to avoid financial assistance issues but can provide a practical solution for timing mismatches.

• Deferred payment structures - companies can manage cash flow through deferred payment arrangements, with an initial payment followed by installments. This requires comprehensive documentation of payment terms and often security for the selling shareholder. The tax implications need careful consideration as timing of payments can affect tax treatment.

• Multiple completion dates - breaking the purchase into stages through a series of smaller buybacks can help match the company's cash availability. This requires precise structuring to ensure enforceability of the overall arrangement and clear triggers for each completion stage. Care must be taken to maintain the commercial cohesion of the transaction.

• Interim dividend route - an alternative approach involves declaring an interim dividend to the selling shareholder which is then used to offset part of the purchase price. This reduces the immediate cash requirement for the buyback but requires careful consideration of tax implications and timing. The structure must ensure the dividend declaration is properly documented and legally valid.

Each funding method carries specific legal and tax implications requiring careful professional advice. The choice of method often depends on the company's financial position, timing requirements, and the commercial needs of all parties involved.

Potential disadvantages and risks

Both legal compliance risks and commercial disadvantages can materially impact the company's position, while improper structuring can invalidate the entire transaction and create personal liability for directors. Headline issues to watch out for based on our experience include :-

• Implications relating to reduction in company's distributable reserves

• Can trigger tax liabilities

• May affect company's market value

• Potential creditor concerns

• Financial assistance concerns - Buyback potentially constituting unlawful financial assistance

• Director duties - Not properly considering creditor interests or company benefit

Share Buyback Agreement

A comprehensive buyback agreement forms the cornerstone of the transaction, protecting all parties' interests and ensuring legal compliance. Essential clauses include :-

• Purchase price and payment terms - including valuation method, timing of payments, and any deferred consideration.

• Warranties about share ownership - confirming clean title, no encumbrances, and power to sell.

• Tax indemnities - protecting company against unexpected tax liabilities arising from the buyback.

• Completion mechanics - clear process for share transfer, payment and document execution.

• Confidentiality obligations - protecting sensitive company information and buyback terms.

• Post-completion restrictions - including non-compete and non-solicitation provisions where relevant.

• Entire agreement provisions - ensuring all terms are captured in one document to prevent disputes.

Key tax considerations

The tax treatment of share buybacks requires careful navigation as it can significantly impact both the company and the departing shareholder. While buybacks can offer tax advantages compared to traditional share transfers, incorrect structuring can result in unexpected tax charges. The key challenge lies in determining whether the buyback will be treated as a capital or income distribution. Overview considerations include :-

• Capital gains tax for selling shareholders - the buyback may trigger CGT unless qualifying for reliefs.

• Stamp duty implications - usually 0.5% on purchase price, payable by company.

• Corporation tax treatment - whether purchase price is treated as income or capital distribution.

• Available tax reliefs - including possible treatment as capital if meeting specific HMRC conditions.

• Impact on entrepreneur's relief - consideration of whether buyback affects Business Asset Disposal Relief.

• Anti-avoidance provisions - ensuring structure doesn't trigger specific anti-avoidance rules.

• Connected party considerations - special rules apply for purchases from connected individuals.