Share buybacks – how to avoid the pitfalls
A share buyback can be a useful way for shareholders to exit a company where no external buyer is available. However, the legal framework is strict, and mistakes can be costly. This guide outlines how share buybacks work in the UK, how they can be funded, and the key risks to be aware of.
A Company Purchase of Own Shares, otherwise known as a “share buyback”, is often used in private companies where an individual shareholder wishes to exit and realise the value of their investment, but there is no willing third-party purchaser.
In these circumstances, the Companies Act 2006 (the “Act”) allows a company to purchase its own shares from its shareholders, subject to any restrictions in the company’s articles of association. The procedure and legal requirements for carrying out a share buyback are set out in Part 18 of the Act.
While this can be an effective solution, there are a number of legal and commercial pitfalls that companies and shareholders should be aware of before proceeding.
The key challenge: funding the buyback
The main hurdle in any share buyback is the availability of funds.
As a general rule, a company must cancel the shares it repurchases (or in some cases, hold them in treasury). This means that a buyback will usually reduce the company’s available funds, which can raise concerns for creditors.
This is where the doctrine of capital maintenance becomes important. In simple terms, companies are restricted from reducing their capital in a way that could undermine the financial position that creditors rely on.
How can a share buyback be financed?
Under section 692 of the Act, a share buyback can be funded in one of the following ways:
- Out of distributable profits; or
- From the proceeds of a fresh issue of shares
For private limited companies only, and subject to strict requirements, a buyback can also be funded out of capital.
Distributable profits (often referred to as “reserves”) are the company’s accumulated realised profits, less its accumulated realised losses. This is calculated across the lifetime of the company, not just a single financial year.
Commercial considerations for directors
Given that the shares are typically cancelled, directors should carefully consider why a buyback is in the company’s best interests.
For public companies, buybacks are often used to return value to shareholders or improve earnings per share. For private companies, the rationale is usually more specific.
Directors must comply with their duties under section 172 of the Act, meaning they must act in good faith to promote the success of the company for the benefit of its members as a whole.
In practice, this means:
- Clearly documenting the commercial reasoning in board minutes
- Considering the impact on remaining shareholders
- Ensuring the transaction can be justified as beneficial overall
A common example is where a director-shareholder is stepping down and will only do so if they can realise the value of their shares. In that scenario, a buyback may support the company’s long-term stability.
Legal procedure for a share buyback
A share buyback requires both board approval and shareholder approval.
- Where the buyback is funded from distributable profits, approval requires a simple majority (over 50%) of voting rights
- Where the buyback is funded out of capital, a special resolution (75%) is required
Importantly, the voting rights attached to the shares being repurchased must be disregarded when calculating approval.
Additional requirements for buybacks out of capital
Buybacks funded out of capital carry greater risk and are subject to additional safeguards.
These include:
- A statement of solvency from the directors, covering the 12 months following the transaction
- A requirement to place a notice in the London Gazette within one week of the shareholder resolution
- The right for creditors or dissenting shareholders to apply to court to cancel the buyback (under section 721)
Directors should approach the solvency statement with particular care. If it proves to be inaccurate, there is a risk of personal liability to creditors.
Because of the additional cost, complexity and delay, buybacks out of capital are relatively uncommon.
The “de minimis” exception
In some cases, companies can rely on a limited exception to avoid the full capital procedure.
This applies where the amount used for the buyback does not exceed the lower of:
- £15,000; or
- 5% of the company’s share capital in a single financial year
While helpful, this exemption is narrow and should be applied carefully.
“Anti-embarrassment” provisions
It is common for an exiting shareholder to request an “anti-embarrassment” provision.
This provides for an additional payment if:
- The company is sold shortly after the buyback; or
- Further shares are purchased at a higher value within a set period
Although commercially understandable, these provisions can be risky in a share buyback context. This is because the consideration for the shares must generally be paid in full at completion.
If not carefully drafted, such provisions could result in the buyback being void.
Conclusion
A share buyback can be a practical and effective way to facilitate a shareholder exit. However, the legal and procedural requirements are strict, and mistakes can have serious consequences, including the transaction being void.
For that reason, it is essential to obtain legal, tax and accountancy advice before proceeding.
How we can help – Business Solicitors in Oldham
If you are considering a share buyback, or need advice on a shareholder exit, our corporate team at O’Donnell Solicitors can guide you through the process from start to finish.
We can advise on structuring the buyback, ensuring compliance with the Companies Act 2006, and protecting both the company and its directors from unnecessary risk.
You can get in touch with our team by phone 01457 761 320 or by email at enquire@odonnellsolicitors.co.uk to discuss your situation in confidence.