Private company share buybacks: avoiding the pitfalls

There has been a significant increase in the number of public companies around the world commencing well-publicised share buyback programmes over the last few years. However, UK private companies have also been eyeing this route as a useful corporate tool to deal with a range of issues that may not have been possible to address since before the Covid-19 pandemic.

Despite this, we want to sound a note of caution. While the buyback route is often an attractive option for a company, is a complex and multi-faceted process that needs to be fully complied with. If certain elements are not complied with, it is possible that the buyback will be declared void. In such cases, it will be as if the relevant shareholder is still on the share register and the buyback did not take place.

In recent years, we have advised a number of companies where a dividend is about to be declared or a third-party sale is being considered. On reviewing the buyback arrangements, we have often found that matters have not been dealt with correctly. This has led to delays to corporate transactions and loss of value to shareholders. 

This article sets out some of the reasons a buyback might be considered and, as importantly, the key steps to follow to ensure that the buyback is valid.

Why carry out a share buyback?

Share buybacks have been implemented by many companies to address any of the following scenarios:

• to return surplus cash to shareholders and optimise the balance sheet, following a period of enhanced profitability or the sale of a business or significant assets;
• to provide liquidity to reduce the number of shareholders on the register, providing for improved administration and more efficient decision-making; and
• to provide an exit route for shareholders, including on retirement or other change in circumstances.

The legislation

A share buyback must be carried out in compliance with Chapter Four of Part 18 of the Companies Act 2006 (Chapter Four). This is a rigid and prescriptive piece of legislation, containing numerous requirements applicable to all aspects of a share buyback. These requirements were originally designed to protect a company’s creditors.

Where a company carries out a share buyback in breach of Chapter Four, the share buyback will usually be void. This can have severe consequences for the company and its directors, most notably that the shares purported to be bought back and cancelled by the company will remain in issue – as if the buyback never took place, and the shareholders in question never sold their shares to the company. In addition, both the company and every director in office at the time of the void buyback will have committed an offence (which could result in a prison sentence, an unlimited fine, or both). A claim for breach of duty may lie against the directors, and the “selling” shareholders may be liable to pay the purchase price they received for their shares back to the company, with interest. Such shareholders may also be entitled to ask for their names to be re-entered on the company’s register of members.

These issues can be particularly problematic if uncovered as part of a due diligence exercise by a prospective purchaser of the company in the event of a sale to a third party, and can affect the ability to carry out such a sale.    

Five key requirements for a valid share buyback

A share buyback can be financed in different ways: out of distributable profits, the proceeds of a fresh issue of shares, or out of capital. This article focuses on share buybacks financed out of distributable profits.

The following are five key requirements that should always be checked when carrying out a share buyback [1]:

1. Check your Articles of Association

A company is permitted to buy its own shares, provided that it is not expressly restricted or prohibited from doing so by its Articles of Association. If a company’s Articles do contain an express restriction or prohibition of buybacks, the Articles must be amended to remove the restriction or prohibition, before the buyback can take place. This will generally require a Special Resolution of the company’s shareholders (although the Articles may specify a more onerous approval threshold to remove the provision in question).

If a company wishes to carry out a small share purchase out of capital using the de minimis exemption [2], the Articles must include a specific authority to do so. If a company’s Articles do not include such a provision, they must be amended (by a Special Resolution of the shareholders) to include language expressly permitting the buyback out of capital before the buyback can take place.

Finally, if the Articles contain more usual pre-emption provisions or any similar restrictions on the transfer of shares, such provisions must be validly waived by the shareholders or, if necessary, amended before the company carries out the buyback.

2. Check your existing share capital

A company may not purchase its own shares if, as a result of the purchase, there will no longer be any shares in issue other than redeemable shares or shares held in treasury. At least one non-redeemable share must remain in issue after completion of the buyback, and that share must not be held in treasury.  

In addition, any shares to be purchased by the company must be fully paid (in respect of the nominal amount and any premium) prior to the purchase. If a company wishes to purchase partly paid shares, it should ensure that the shares are fully paid up before undertaking the buyback (or, as an alternative, carry out a reduction of capital to reduce the nominal value of each share by the unpaid amount).

3. Prepare a share buyback contract

A company may only purchase its own shares if a share buyback contract between the company and the selling shareholder has been approved by shareholders before the purchase. The buyback contract should set out the main terms of the buyback and contain enough information for shareholders to consider the proposed transaction and make an informed voting decision. This should include the price to be paid for the shares and the number and class of shares being sold.

4. Obtain shareholder approval

The share buyback contract must be approved by the shareholders of the company, either before it is entered into or, if after, before any shares are purchased by the company. An Ordinary Resolution of the shareholders will be sufficient, unless the Articles require a higher majority or unanimity.

If shareholder approval is sought by way of written resolution, a copy of the buyback contract must be sent to every eligible member at the same time as (or before) the written resolution is sent. As such, every shareholder will see the terms of the buyback. If shareholder approval is sought at a general meeting, a copy of the buyback contract must be made available for inspection by the shareholders both at the general meeting and for at least 15 days before.

The selling shareholder is not entitled to vote on the written resolution, or to vote the shares being purchased on a resolution at a general meeting.

5. Ensure consideration is paid at completion, in cash

Shares purchased by the company under a share buyback must be paid for in full, in cash, on completion. They cannot be paid for in instalments or by way of deferred consideration. The purchase price cannot be left outstanding on loan account. The company must have sufficient distributable profits to fund the buyback in full.

A buyback contract that contains an anti-embarrassment provision (to protect against the risk of shares in the company being sold for a higher price in the future) is likely to render the buyback void, if it provides that further consideration may be paid for the buyback shares after the original buyback has been completed.

A buyback contract may provide for a series of separate buybacks that complete on different dates, provided that the consideration for each buyback is paid on completion of that buyback. However, the company must have sufficient distributable profits to pay for each tranche of shares to be bought back at the time of purchase. Entering into a buyback contract that provides for multiple completions over a period of time engenders a risk that the company will not have sufficient distributable profits to fund the buyback on the relevant completion date.

Other considerations

Following completion of the share buyback, the register of members of the company must be updated to reflect the purchase from the selling shareholder and, if relevant, the cancellation of the shares. The company may also be liable to pay stamp duty on the purchase price of the shares and must ensure any filings as required are made at Companies House. Updates may also be required to the company’s register of people with significant control.   

Rectification of a void share buyback

When a share buyback is recognised to be void, it is possible for the company to take action to rectify the situation. This can take the form of carrying out the share buyback again, in compliance with the requirements of Chapter Four. Alternatively, the company can cancel the shares it purportedly bought back pursuant to a reduction of capital. The company may choose to apply for a court-approved reduction of capital, which, if successful, has the advantage of providing conclusive evidence as to the identity of the company’s shareholders and its share capital.

[1] This article does not consider share buybacks funded out of capital or pursuant to an employee share scheme, in respect of which there are further specific requirements and exceptions.

[2] Up to an aggregate purchase price in any financial year of the lower of £15,000, or the nominal value of 5% of the company’s full paid share capital at the beginning of the financial year.