Buy Back of shares under the Companies Act, 1956 - An Insight

The provisions regulating buy back of shares are contained in Section 77A, 77AA and 77B of the Companies Act,1956. These were inserted by the Companies (Amendment) Act,1999. The Securities and Exchange Board of India (SEBI) framed the SEBI(Buy Back of Securities) Regulations,1999 and the Department of Company Affairs framed the Private Limited Company and Unlisted Public company (Buy Back of Securities) rules,1999 pursuant to Section 77A(2)(f) and (g) respectively. Objectives of Buy Back: Shares may be bought back by the company on account of one or more of the following reasons i. To increase promoters holding ii. Increase earning per share iii. Rationalise the capital structure by writing off capital not represented by available assets. iv. Support share value v. To thwart takeover bid vi. To pay surplus cash not required by business Infact the best strategy to maintain the share price in a bear run is to buy back the shares from the open market at a premium over the prevailing market price. Resources of Buy Back A Company can purchase its own shares from (i) free reserves; Where a company purchases its own shares out of free reserves, then a sum equal to the nominal value of the share so purchased shall be transferred to the capital redemption reserve and details of such transfer shall be disclosed in the balance-sheet or (ii) securities premium account; or (iii) proceeds of any shares or other specified securities. A Company cannot buyback its shares or other specified securities out of the proceeds of an earlier issue of the same kind of shares or specified securities. Conditions of Buy Back (a) The buy-back is authorised by the Articles of association of the Company; (b) A special resolution has been passed in the general meeting of the company authorising the buy-back. In the case of a listed company, this approval is required by means of a postal ballot. Also, the shares for buy back should be free from lock in period/non transferability.The buy back can be made by a Board resolution If the quantity of buyback is or less than ten percent of the paid up capital and free reserves; (c) The buy-back is of less than twenty-five per cent of the total paid-up capital and fee reserves of the company and that the buy-back of equity shares in any financial year shall not exceed twenty-five per cent of its total paid-up equity capital in that financial year; (d) The ratio of the debt owed by the company is not more than twice the capital and its free reserves after such buyback; (e) There has been no default in any of the following i. in repayment of deposit or interest payable thereon, ii. redemption of debentures, or preference shares or iii. payment of dividend, if declared, to all shareholders within the stipulated time of 30 days from the date of declaration of dividend or iv. repayment of any term loan or interest payable thereon to any financial institution or bank; (f) There has been no default in complying with the provisions of filing of Annual Return, Payment of Dividend, and form and contents of Annual Accounts; (g) All the shares or other specified securities for buy-back are fully paid-up;

Filing of Declaration of solvency After the passing of resolution but before making buy-back. c.(h) The buy-back of the shares or other specified securities listed on any recognised stock exchange shall be in accordance with the regulations made by the Securities and Exchange Board of India in this behalf. a return in form 4 C containing such particulars relating to the buy-back within thirty days of such . and (e) the time-limit for completion of buy-back Sources from where the shares will be purchased The securities can be bought back from (a) existing security-holders on a proportionate basis. (b) the necessity for the buy-back. Filing of return with the Regulator A Company shall. and signed by at least two directors of the company. b. such other particulars as may be prescribed Where a company buys-back its own securities. (d) the amount to be invested under the buy-back. that is to say. A company which has bought back any security cannot make any issue of the same kind of securities in any manner whether by way of public issue. Disclosures in the explanatory statement The notice of the meeting at which special resolution is proposed to be passed shall be accompanied by an explanatory statement stating (a) a full and complete disclosure of all material facts. is smaller than such marketable lot. as may be specified by the stock exchange. Buyback of shares may be made by a tender offer through a letter of offer from the holders of shares of the company or (b) the open market through (i). the consideration paid for the securities bought-back. book building process. rights issue up to six months from the date of completion of buy back. (c) the class of security intended to be purchased under the buy-back. where the lot of securities of a public company. (ii) stock exchanges or (c) odd lots. The declaration must be verified by an affidavit to the effect that the Board has made a full inquiry into the affairs of the company as a result of which they have formed an opinion 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. a company shall maintain a register of the securities/shares so bought and enter therein the following particulars a. Issue of further shares after Buy back Every buy-back shall be completed within twelve months from the date of passing the special resolution or Board resolution as the case may be. after the completion of the buy-back file with the Registrar and the Securities and Exchange Board of India. and (i) The buy-back in respect of shares or other specified securities of private and closely held companies is in accordance with the guidelines as may be prescribed. the date of cancellation of securities. file with the Registrar and the Securities and Exchange Board of India a declaration of solvency in form 4A. or (d) purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity. the date of extinguishing and physically destroying of securities and d. whose shares are listed on a recognized stock exchange. it shall extinguish and physically destroy the securities so boughtback within seven days of the last date of completion of buy-back. Register of securities bought back After completion of buyback. if any: No declaration of solvency shall be filed with the Securities and Exchange Board of India by a company whose shares are not listed on any recognized stock exchange. one of whom shall be the managing director.

Prohibition of Buy Back A company shall not directly or indirectly purchase its own shares or other specified securities (a) through any subsidiary company including its own subsidiary companies. or tender. it shall. which often causes the share price to shoot up. After all.completion. Thus. When this happens. on the earnings of the company. b. No return shall be filed with the Securities and Exchange Board of India by an unlisted company. also known as a "share repurchase". h. we will look at one of those overlooked methods: share buybacks. or with both. a portion or all of their shares within a certain time frame. The idea is simple: because a company can¶t act as its own shareholder. We¶ll go through the mechanics of a share buyback and what it means for investors. d. that when a company announces a buyback it is usually perceived by the market as a positive thing. Open Market The second alternative a company has is to buy shares on the open market. this statement is not always true. A draft letter of offer shall be filed with SEBI through a merchant Banker. A Breakdown Of Stock Buybacks There are a number of ways in which a company can return wealth to its shareholders. or (b) through any investment company or group of investment companies. at the market price. Once the company has received all of the offers. one Hindi National daily and Regional Language Daily at the place where the registered office of the company is situated. Now let¶s look at why a company would initiate such a plan. or with fine which may extend to fifty thousand rupees. or claims. 2. c. The Meaning of Buybacks A stock buyback. there are other useful. when a company spends millions of dollars buying up its own shares. however. Penalty If a company makes default in complying with the provisions the company or any officer of the company who is in default shall be punishable with imprisonment for a term which may extend to two years. buybacks are carried out in one of two ways: 1. Where a company proposes to buy back its shares. The date of opening of the offer shall not be earlier than seven days or later than 30 days after the specified date g. Although this can sometimes be the case. The tender offer will stipulate both the number of shares the company is looking to repurchase and the price range they are willing to pay (almost always at a premium to the market price). Although stock price appreciation and dividends are the two most common ways of doing this. which shall be "specified date" for the purpose of determining the names of shareholders to whom the letter of offer has to be sent. You can think of a buyback as a company investing in itself. e. A copy of the Board resolution authorising the buy back shall be filed with the SEBI and stock exchanges. For example. and often overlooked.1956. The buy back offer shall remain open for a period of not less than 15 days and not more than 30 days. ways for companies to share their wealth with investors. The prototypical line in a buyback press release is "we don't see any better investment than in ourselves". an accounting scandal or just a poor overall economic climate. they will state the number of shares they want to tender along with the price they are willing to accept. or using its cash to buy its own shares. just like an individual investor would. it will find the right mix to buy the shares at the lowest cost. or Procedure for buy back a. A company opting for buy back through the public offer or tender offer shall open an escrow Account. The public announcement shall specify a date. . When investors take up the offer. Nevertheless. of course compoundable under Section 621A of the Companies Act. it says management believes that the market has gone too far in discounting the shares . there are still sound motives that drive companies to repurchase shares. It is important to note. after passing of the special/Board resolution make a public announcement at least one English National Daily. Typically. they¶ll likely tell you that a buyback is the best use of capital at a particular time. The letter of offer shall then be dispatched to the members of the company. The offences are. A public notice shall be given containing disclosures as specified in Schedule I of the SEBI regulations. and a buyback generally increases shareholder value. and the number ofoutstanding shares on the market is reduced. In this article. the goal of a firm's management is to maximize return for shareholders. f. The Motives If you ask its management. Tender Offer Shareholders may be presented with a tender offer by the company to submit. the relative ownership stake of each investor increases because there are fewer shares.a positive sign. management many feel the market has discounted its share price too steeply. A stock price can be pummeled by the market for many reasons like weaker-then-expected earnings results. repurchased shares are absorbed by the company. is a company's buying back its shares from the marketplace.

Let¶s look at how this happens. Watch out. its ROA was 4% ($2 million/$50 million) but after the repurchase. that the shares in the company had increased by one million. however.2). if we assume that the shares remain at $15. a change in the number of outstanding shares can affect key financial measures such as EPS and P/E. it has the opposite effect of repurchase: it weakens the financial appearance of the company. the market views higher ROA and ROE as positives. even though earnings have not changed.Part 1. This motivation is questionable.71% ($2 million/$35 million). the question may not have a definitive answer. return on assets (ROA) actually increases because assets are reduced. At the risk of oversimplification. a major advantage that buybacks had over dividends was that they were taxed at the lower capital-gains tax rate. whereas dividends are taxed at ordinaryincome tax rates. Tax Benefit In many ways.Improving Financial Ratios Another reason a company might pursue a buyback is solely to improve its financial ratios ± metrics upon which the market seems to be heavily focused.companies have to compete to retain personnel and ESOPs comprise many compensation packages. In the case of dilution. return on equity (ROE) increases because there is less outstanding equity. its EPS would have fallen to $0. A similar effect can be seen in the EPS number. Because cash is an asset. this will lower the total assets of the company from $50 million to $35 million. a buyback is similar to a dividend because the company is distributing money to shareholders. Moreover. In this case. and reduces the number of shares outstanding in the process. After years of lucrative stock option programs. Traditionally. there is likely to be a problem with the management. Conclusion Are share buybacks good or bad? As is so often the case in finance. share buybacks reduce the number of shares outstanding. instead. the P/E ratio before the buyback is 75 ($15/$0. This then leads to an increase in its ROA.) Suppose a company repurchases one million shares at $15 per share for a total cash outlay of $15 million. provide short-term relief to an ailing stock price or to get out from under excessive dilution.can be viewed as a positive sign for shareholders. Below are the components of the ROA and earnings per share (EPS) calculations and how they change as a result of the buyback.) Bull markets and strong economies often create a very competitive labor market .22) due to the reduction in outstanding shares. Once a company purchases its shares. if a company¶s motive for initiating a buyback program is sound. (See Reading The Balance Sheet. let¶s assume. As was seen in the above example. In other words.22 ($2 million/9 million shares).20 ($2 million/10 million shares) to $0. a company may feel the need to repurchase shares to avoid or eliminate excessive dilution. Continuing with the previous example. after the buyback.20/share. Stock options have the opposite effect of share repurchases. (See Option Compensation . which increases from $0.18 per share from $0. ROA increases to 5. the tax rate on dividends is now equivalent to the rate on capital gains. However. fewer shares + same earnings = higher EPS! Based on the P/E ratio as a measure of value. First of all. . it often cancels them or keeps them as treasury shares.and its effects . the company is now less expensive than it was prior to the repurchase despite the fact there was no change in earnings. the improvement of its financial ratios in the process may just be a byproduct of a good corporate decision. Dilution Another reason that a company may move forward with a buyback is to reduce the dilutionthat is often caused by generous employee stock option plans (ESOP). as they increase the number of shares outstanding when the options are exercised. with the passing of the Jobs and Growth Tax Relief Reconciliation Act of 2003. when it comes to the P/E ratio. the company¶s cash hoard has been reduced from $20 million to $5 million. the market often thinks lower is better. the buyback . As a result. If a stock is undervalued and a buyback truly represents the best possible investment for a company. the P/E decreases to 68 ($15/$0. Prior to the buyback. In general. buybacks reduce the assets on the balance sheet (remember cash is an asset). As you can see. The buyback also helps to improve the company¶s price-earnings ratio (P/E). The P/E ratio is one of the most well-known and often-used measures of value. If reducing the number of shares is not done in an attempt to create more value for shareholders but rather make financial ratios look better. if a company is merely using buybacks to prop up ratios. Part 2 and The ³True´ Cost Of Stock Options. However. Therefore.

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