BUY BACK OF SHARES

Table of Contents

Buy Back is the corporate action in which a company buys back its shares from the existing shareholders usually at a price higher than the market price. When the company buys its shares back, the number of outstanding shares in the market reduces.

Buy Back of Shares is also known as ‘REPURCHASE OF SHARES.’

A Buy Back allows a company to invest in themselves. By reducing the number of shares outstanding in the market, buy backs increase the proportion of shares a company owns. The buy back of shares is governed by the section 68 of the Companies Act 2013.

MODES OF BUY BACK

Shareholders may be presented with a tender offer whereby they have the option to submit a portion or all of their shares within a certain time period.

Companies buy back their in the open market over the extended period of time.

REASONS FOR BUY BACK OF SHARES

The following are the reasons for buy back of shares:

To improve the earnings per share.
To improve the return on capital or Return on net worth and to enhance the long term shareholder’s value.
To provide an additional exit route to shareholders when shares are undervalued.
To enhance consolidation of stake in company.
To prevent unwelcome takeover bids.
To return surplus cash to shareholders.
To achieve optimum capital structure.
To support share prices during poor market conditions.

LEGAL PROVISIONS REGARDING BUY BACK

The buyback of shares are regulated under the Section 68 of Companies Act and provisions of SEBI (Securities Exchange Board of India). The following are the legal provisions regarding buyback:

SOURCES OF FUNDS FOR BUY BACK

The shares may be bought back by arranging the funds from the various sources which are as follows:

Free reserves
Securities premium account
Proceeds of issue of shares or specified securities.

AUTHORIZATION AS PER ARTICLES OF ASSOCIATION

There must be a provision in the Articles of Association authorizing the company to buy back its own shares. An Articles of Association is the document governing the internal affairs of the company.

PASSING OF SPECIAL RESOLUTION

A special resolution must also be passed in the general meeting by the Board of Directors. The resolution must specify:

The buyback of 25% shares or other specified securities of paid up capital.
Buyback of equity shares should not be more than 25% of total paid up capital in any financial year.
Approval of buyback of 10% of equity paid up capital only.

RESERVE OF AMOUNT FOR BUY BACK

The listed company shall ensure that atleast 50% of the amount is reserved for buy back in specified securities.

DEBT-EQUITY RATIO

The Debt Equity ratio of the company after the buyback should not be more than the standard i.e. 2:1.

EQUITY SHARES MUST BE FULLY PAID UP

The Section 68 of the Companies Act states that the equity shares to be bought back must be fully paid up.

COMPLIANCE WITH SEBI GUIDELINES

In case the company has listed its shares or other specified securities in Stock Exchange, then the buyback must be in accordance with the SEBI Guidelines.

NOTICE OF THE MEETING FOR BUY BACK

The notice of the meeting at which the special resolution on buy-back is proposed to be passed has to be accompanied by the explanatory statement providing for:

A full and complete disclosure of all material facts.
The necessity for buy back
The class of shares or security intended to be purchased under the buy back
The amount to be invested under the buy back
The time limit for the completion of buy back.

TIME FOR COMPLETION OF BUY BACK

Every buy-back should be completed within 12 months from the date of passing the special resolution.

DISPOSAL OF SHARES BOUGHT BACK

The equity shares bought back shall be extinguished and physically destroyed within 7 days from the date of buy back.

OTHER PROVISIONS

The other provisions regarding buy back are as follows:

No buy back should be made out of proceeds of an earlier issue of same kind of shares or same kind of other specified securities.
The amount credited after the close of financial year to free reserves and the securities premium should not be utilized for the buy back.
A company can issue bonus shares at any time after the buyback of shares.
No new shares can be issued within 6 months except bonus shares.
Passing of resolution may not create any obligation on the company to buy back its own shares.
The payment for buy back will be done by the way of cash/bank overdraft or cheque only.
Cost of the buy back is taken as an expense and will be charged to profit and loss account.
Buyback of shares cannot be done from promoters.

ADVANTAGES OF BUY BACK OF SHARES

IMPROVES EARNING PER SHARE

Buy back improves the market value of the shares. It results in higher earnings per share. As a result the demand of purchase of shares increases and the market price of shares increases.

PREVENT UNWELCOME TAKEOVER BIDS

Buyback helps in avoiding the takeover bids by the big companies. The buyback of shares reduces the stock from the market. The right of controlling the company by the promoters increases. It acts as a defensive mechanism against exploitative takeover bids.

EFFECTIVE UTILISATION OF SURPLUS CASH

The buyback facilities enable the company to manage their cash effectively. Many companies in this country face the problem of surplus cash and have no idea to invest them profitably. So, it would be better to return the surplus money to the shareholders.

INDICATION OF FUTURE PROSPECTS

The buyback decision expresses clearly the view of the management that the future prospects are good and investing in its own shares is the best option. Also, the announcement of buy-back point out that the market is undervaluing the company’s shares in their book value.

ENSURES MAXIMUM RETURN TO SHAREHOLDERS

Buy-back increases the return on the shares as it leads to the decrease in the number of equity shares. So the profits can be divided in the increased ratio.

CONVENIENT AS COMPARED TO CAPITAL REDUCTION

Buyback of shares facilitates reduction of share capital without recourse to lengthy capital reduction process and a company can suitably swap up equity for debt.

OTHER ADVANTAGES

The other advantages of buyback are as follows:

It enhances the consolidation of the stake in the company.
It helps in achieving the optimum capital structure.
It supports the share prices during poor periods.
It helps in serving the equity more efficiently.

LIMITATIONS/ DISADVANTAGES OF BUY BACK

The limitations of buy back are as follows:

ENCOURAGES INSIDER TRADING

Buy-back facility may prompt the promoters to resort to inside trading for their selfish interests. The promoters before the buy-back, may understate the earnings by manipulating the accounting policies and highlight other unfavorable factors affecting the earnings. This would result into fall in the market price of the shares and will provide an opportunity to the promoters to buy them at the lower prices. In this manner the insider would make extra money when the company buy-back these shares at higher prices.

MANIPULATION OF SHARE PRICES

Buy-back of shares may lead to artificial manipulations of stock prices in the stock exchange by groups having vested interests and thus creating confusion and loss to the innocent shareholders.

WEAKENING MINORITY SHAREHOLDERS STAKE

Buy-back mechanism is generally used by the promoters to enhance and consolidate their controlling interests in their companies as a result of which the position of minority shareholders is weakend.

ACCOUNTING TREATMENT FOR BUY BACK OF SHARES

SALE OF INVESTMENTS FOR BUY BACK OF SHARES

1.If sale is at profit

Bank A/c Dr.
To Investments A/c
To Statement of profit and loss A/c

2.If sale is at loss

Bank A/c Dr.
Statement of profit and loss A/c Dr.
To Investments A/c

ISSUE OF DEBENTURES OR OTHER SPECIFIED SECURITIES FOR THE BUY-BACK OF SHARES

Bank A/c Dr.
To Debentures Account
To Specified Securities Account

ENTRY FOR PAYMENT FOR BUY-BACK OF SHARES

1.When shares are bought back at par

Equity Share Capital A/c Dr.
To Bank Account

2.When shares are bought back at premium

Equity Share Capital A/c Dr.
Premium on buy-back Account Dr.
To Bank Account

3.When shares are bought back at discount

Equity share capital A/c Dr.
To Bank Account
To Capital Reserve Account

CREATION OF CAPITAL REDEMPTION RESERVE

Free reserves Account Dr.
Securities Premium Account Dr.
To Capital Redemption Reserve A/c

WRITING OFF PREMIUM ON BUY-BACK ACCOUNT

Securities Premium A/c Dr.
General Reserve A/c Dr.
Statement of Profit and Loss A/c Dr.
To Premium on buy back A/c