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Chapter

BUY-BACK OF EQUITY SHARES

ME~ND EFFECTS
Buy-back of shares means the repurchase of i t s ~ e s by the company. When a company has sufficient cash
resources, it may like to buy its own equity shares from the market, particularly when the prevailing rate of its equity
-shares in the market is much lower than the face value. The shares thus bought back have to be cancelled.
The effects of the buy-back are stated below :
(i) There is a reduction in the share capital equivalent to the face value of the shares purchased back.
(ii) A reduction in the number of shares outstanding without affecting its earnings and thus, increasing the company'
e~ nings per share.
(iii) A payment from the bank of the company equivalent to the price paid for buying the shares.
(iv) The names of the shareholders whose shares are bought back are removed from the register of members with
the result that they are not entitled to receive any dividend in future.

OBJECTIVES OR REA~F BUY-BACK OF SHARES

Buy-back of equity shares may be done for the fo~jectives or reasons:
(i) It enables the company to utilise its SUIJllilS cash.
(ii) It would generally increase the e~gs share provided there is no fall or reduction in future profitability.
(iii) It would increase intrinsic value of shares because lesser number of shares have claims on the net assets.

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(iv) It prevents the takeov.er of the companies by the competitors.
(v) It increases the shareholding of the promoters.
(vi) It enables the company to achieve internal recgnstrgction by malting the share capital compatible with the real
value of the assets through the process of reducing the share capital.
(vii) It prevents the downward trend or fall in the value of shares.

ADVANTAGES OR BENEFITS OF BUY-BACK

B.uy-back of equity shares offers the following advantages or benefits to the company :
(i) The company can use its surplus cash which is lying unutilised and there are no proper investment opportunities
(ii) It improves the return on capital (ROC), net profitability and also earning per share.

(iii) It enables the settlement with dissatisfied or dissenting members of the company.
(iv) It enables the company to buy the shares of the retiring employees.
(v) The existing promoters or managements can keep their control over the company because ofless shares available
for sale in the market. In other words, it makes difficult the hostile takeover attempts.
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,amount of dividend and increase in the
Ir h because Of more
(vi) The remaining shareholders are ~ept appy . making steady progress.
value of their shares in the long run provided the company is
. d . ce the company encourages the shareholders to seU
(vii) Fractional share-holdings and odd lots can be av01de sm
lot shares.
(viii) It brings liquidity in the hands of the investors.
(ix} It rationalises the capital structure of the company.

~~ERS Of BUY-BACK . .
It is feared that the buy-back may be misused by the corporate entities at the cost of mnocent mvestors. The inher~
dangers may be listed as :
(i) · It will provide an ample opportunity for inside trading. The promoters, before the buy-back, may understi!i
the earnings by manipulating accounting policies, say, in respect of depreciation, valuation of inventories etc.
This would lead to a fall in the quoted prices of shares and the promoters would buy them at low quotations.~
· this manner, the insiders would make extra money when the company buys-back these shares at a higher pria
(ii) Buy-back may lead to artificial manipulations of stock prices.
(iii) The position of the minority shareholders is weakened as buy-back enables the management to incml!
their control over the company.

SOUR~l=BUY-BACK [SECTION 68)

T~e salient features of Section 68 relating to buy-back of shares have been ·ven in the folio · ar hs under
swtable heads for the benefit of the students. gi wmg p agrap
A company may purchase its own shares or other specified securities out of:
(i) Its free reserves; or
(ii) The securities premium account; or
(iii) The proceeds of any shares or any other securities. However, It
• must be clarified that .
(a) No buy back shall be made out of the proceeds of an Ii . • kiJ!d
of other specified securities. ear er issue of the same kind of shares or same
( b) When a company
. al al purchases its own shares out of free reserves Sectio 69
f th . th.. t- "' c:nm eau~ tbt
nomm v ue o e shares so purchased shall be t £ • n requires ~A,..,Ofl~
Capital Redemption Reserve Account-can 6e use:ans erred to ~ apital Redemption R~
-= only to Issue fii1Iypafcf6onus shues.
FR~SERVES
Free reserves means such reserves, which as per the latest audi d .

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{of
distrib~~{Section 2(43) te balance sheet of the company are a v ~
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For buy-back of shares. 'Free Reserves' includes, securitiesspremi
c:.:www - um account.(Expl ti 11 tion 68)·
Example of Free Reserves ana on to sec
(i) Surplus/profit as shown by Profit and Loss Statement
(ii) General Reserve
(iii) Dividend Equalization Reserve
Various Funds (after deducting, liability, if any) such as Workmen, Compensation Fund, Insurance fun dai1d
(iv)
so on
(v) Sinking Fund
Buy-Back ofEquity Shares
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(vi) Investment Fluctuation Reserve.
From the foregoing divisible profit fr :
. II S . s or ee reserves foll . .
[Explanation ection 68]: . ' owmg adJustments or deductions should be made

(a) Accumulated depreciation not provided for.

(b) Accumulated losses

(c) Any diminution or reduction in the val

.. ue oflong-term investments and tangible fixed assets.
(d) Writing off the purchased goodwill
. 1u ding d eferred revenue expenditures.
(e) Balance in the miscellaneous expenditures me

EXAMPLE OF RESERVES NOT_~~AILA~URCE OF BUY-BACK

(i) Revaluation Reserve

(ii) Capital Redemption Reserves

(iii) Debenture Redemption Reserve

(iv) Shares Forfeited Account

(v) Profits Prior to Incorporation
(vi) Capital Reserve

{vii) Statutory Tax Reserves.

. ~ U ATTENTION
Capital Reserve : Any profit resulting from the e of fixed assets or long-term investment for cash and is directly credited to
capital reserve is treated as free reserve.
But if no details are given, capital reserve is not treated as free reserves. Statutory Tax Reserve : The reserves under the Income
Tax Act such as Investment Allowance Reserve, Development Rebate Reserve, Exports Profit Reserve, Foreign projects Reserves,
Exchange Earning Reserve etc., are called Statutory Reserves. According to law these reserves become Free Reserves after~
years but before that these reserves are not free, i.e. not available for distribution as dividends. For example, Investment Allowance
Reserve given in the balance sheet is not a free reserve. On the other hand if there are clear hints in the examination problem
about Investment Allowance (utilised) Reserve, the same becomes free reserve for dividend and also for buy-back of shares.

, SECURITIES P~COUNT . .
Securities premium includes premium on shares as well as other securities such as debentures, bonds etc. and can be
used for buy-back of shares. It is made clear that Securities Premium Account can be used for buy-back even though
there may be unamortized items such as: Loss on the issue of debentures, expenses on the issue of securities etc. under
the head: Current Assets : Other Current Assets given as assets in the Balance Sheet.

TRANSFER TO CAPITAL REDE~N-11ESERVE ACCOUNT

Where the company purchases (or buy-back) its own shares out of free reserves, then a sum equivalent to the nominal
value of the shares so purchased, shall be transferred to Capital Redemption Reserve Account and details of such
tranfers shall be disclosed in the Balance Sheet. I?.~ .
Explanation II to section 68 provides that for the purpose of thi' section, Free Reserves include Securities Premium
Account.
PROCEEDS OF E~~SSUE

Tbe following points may be noted in this regard :

(a) Buy-back of equity shares is not allowed out of fresh issue of equity shares.
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. •
urit1es o th e r than equity shares b as prefiet
f hsuch
(b) However, buy-back is allowed out_ 0f artier issue of sec
an ~or the purpose of redemption. . This is also true o t e uy-baclcof
shares, debentures etc., made specifically
other type of security e.g., preference shares. ACK
TERMS AND CONDITIONS OF BUY-8 .
Section 68(2) provides that . con ditions before it can purchase its own shares
- a company must fulfill the followmg
other specified securities:
. . d b 1't Articles of Association.
(iY'The buy-back is authonse Y s . uthorizing the companytopur 1.•.
/ . almeetin ofthecompanya C..,
(ii) _,.<A special resolution has_ been passed m ~e gener. the / ecial resolution is proposed to be Passed shoull I
/ its own shares. The notice of the meeting at which p ,
accompanied by an explanatory statement stating:
(a) a full and complete disclosure of all material facts; .
(b) the necessity for the buy-back;

(c) the class of shares or securities intended to be purchased under the buy-back;
(d) the amount to be invested under the buy-back; and
(e) the time limit for completing of buy-back;

FOR YOUR INFORMATION

However, a buy-back upto IO per cent of the total paid up capital and free reserves of the company can be made simply by the
Board of Directors' resolution and there is no need for special resolution to be passed in the general meeting.
(iii) Over-all buy-back limit in a financial year
/ (a)
Buy-back can be made up to 25% of the paid up capital and free reserves. It means that it may be less tho
25% <'f the total paid up capital and free rese_
rves of the company but not more than 25%.

(b) In respect of the buy-back of equity shares in any financial year, the reference to 25% restriction wou!O
mean 25% of the total paid up equity capital in that financial year.

(c) The ratio of '!'e

aggregate secured and unsecured debts owed by the company after the buy-bade
more than twice the paid up capital and its free reserves.
is••
[It means that debt-equity ratio should not be ~ore than 2:I].

[However, the Central Government may prescribe a higher ratio than th . . . ., for a cJ,ll
or classes of companies.] at specified m this dau

FOR YOUR INFORMATION

The maximum amount of buy-back amount in a financial year Will b ()
th
(b) and (c) e e loweS t 0 fthree figures calculated in points a'
j!Y)- Fully paid up: All the shares or other specified securities £ b
(v) The buy-back of the shares or other specified securities lior duy-back must be full y p aid up. b<
accordance with the regulations made by' Security and Exc:e on any recognized stock exchange .01u r
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(vi) The buy-back m . respect of any company not listed 00 a ange Board of India (SEBI) in this beha1£ JaJI"
·
with the rules as may be prescribed. ny recognized stock exchange must be in accor
Rule J7 of the Companies (Share Capital and Debentures) 11.uJ ,..i
other specified securities. es 20 14 deals With the buy-back of sbatfS
(VI.i) C 0 mpletion of buy-back- Every buy-back must be completed . h. uie
f asslng of special resolution or Board of Directors' re ~It . lil • period of one year ( 12 months) fronl
date o p so Ubon, as the case may be