The share buyback is a process of buying back equity shares by the company from its shareholders. It is a corporate action event in which a firm makes a public statement for a buyback offer to acquire existing shareholders’ shares within a certain timeframe. The buyback of shares is also known as a stock buyback or repurchase of shares.
The buyback policy is set and governed by two authorities; SEBI and the companies act. Every company opting for buyback should strictly adhere to the buyback policy set by the authorities.
The Companies Amendment Act, 1999 introduced the concept of buy-back of shares. Prior to the amendment of the Companies Act, 1956, buyback of shares in India was prohibited.
The buyback of shares is governed by SEBI (Buyback of Securities) Regulations 1998 which has now been replaced with SEBI (Buyback of Securities) Regulations 2018 which was implemented on September 11, 2018. In the year 2019, a small amendment was made to this regulation.
Reasons for buyback of shares
Buyback is generally carried out at a price higher than the market price of the share. There are numerous reasons a company may opt for a buyback of shares. Following are the detailed reasons for the buyback of shares.
1. Undervalued Stock
This is one of the most important reasons for the buyback of shares. When management of the company feels like the stock is undervalued, they adopt the buyback method to rectify the stock price. The buyback is generally carried out at a price higher than the market price. The total number of shares in the market was reduced after the buyback hence leading to an increase in price.
2. Excess Cash and Not Many Rewarding Opportunities
If there are not enough projects to invest in, or there is the availability of excess cash, a company may carry out a buyback of shares. In a way, the company rewards its shareholders.
3. Tax Effective
The dividend is taxed at both company and the investor level. While in the buyback, only the company needs to pay the tax, the capital gain tax for investors from the buyback is exempted. Due to this reason, the buyback of shares is considered the most effective way of rewarding shareholders.
4. Consolidate Hold Over Company
More shareholders result in differences of opinion and share voting conflicts which delay the unanimous decision-making for the company. The increase in promoters’ holding will result in stronger management and solving this issue. Apart from this, higher promoters’ holding will protect the company from possibility of the hostile takeovers.
5. Changing Capital Structure
The capital structure of a company is represented by its debt-equity ratio. Each industry has a different capital structure, where some companies cannot use more debt to run the business, while some company has to rely mostly on debt for their business. Thus, as per the company requirement, the company may opt for buyback for achieving optimum capital structure.
6. Returning Cash to Shareholders
Historically, we have seen many corporations expand into unrelated fields simply because they were rich with cash. A better solution could be to return the cash to shareholders and allow them to pick what to do with the extra funds.
7. Promoters’ Stance of Buyback
Many times promoters can be pushy about executing the buyback. It can be for growth reasons or personal agendas too. When promoters are involved in multiple businesses, they might be looking to fund the growth of some other organization. In such cases, the route of selling off their stake in buyback at higher than market rates is also preferred sometimes.
Conditions for buyback of shares
The companies need to follow multiple conditions of buyback of shares and buyback policy as stated by the companies act and the SEBI. These common conditions are also salient features of buyback. Total 10 conditions for the buyback of shares set by SEBI. Here is a list of a few common conditions of buyback of shares for listed companies as stated by SEBI.
- For companies, there is no specified frequency for carrying out buyback, but a minimum gap of a year is compulsory between the expiry date of one buyback and the next buyback.
- A company shall not buyback its shares or other specified securities so as to delist its shares or other specified securities from the stock exchange.
- The maximum limit of any buy-back shall be twenty-five percent or less of the aggregate of paid-up capital and free reserves of the company.
- A company may buyback equity shares from the market by any of three methods of buyback; Tender Offer, Open Market Offer, and Odd Lot Holders.
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Benefits of buyback of shares
The advantage of the buyback is not just limited to shareholders, but also is significantly rewarding for companies.
- From the company’s point of view, buyback boosts the share price, improves the key financial ratios like EPS, RoE, and RoA, and works as a health checker for the company.
- The buyback provides an opportunity for shareholders to exit at a higher price than the market. With the reduced number of shares, EPS will see a rise.
- The capital gain tax made from the buyback is exempted from tax, which is also a motivating tool for shareholders to participate in the buyback. It helps the company utilize its unused cash and is a tax-efficient way to reward its shareholders.
Conclusion
Buyback of shares is the most common method used by companies to reward their shareholders, increase the market value of the company and get a hold of promoters over the company. It is a tax-efficient way for companies to utilize the unused cash rather than giving out dividends. Under the laws of SEBI and the companies act, the buyback carried out in the stock market has proven to be profitable for many shareholders over the years.
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FAQs
The stock buyback can be good for investors as the gains on it are tax-free, but it can be more beneficial in terms of returns if a shareholder owns the shares at a significantly lower price.
Any shareholder who owns the shares of the company before the record date of the buyback is eligible for the buyback of shares.
Buyback of shares is good for shareholders to gain tax-free returns and have a share in the portfolio that has now touched its intrinsic value.
