A Buyback of Shares occurs when a company repurchases its own shares from its existing shareholders. This strategic action is used to restructure capital, improve financial ratios, and return excess cash to investors. In India, this is strictly governed by Sections 68, 69, and 70 of the Companies Act, 2013.

1. Strategic Objectives

Companies generally opt for a buyback to:

• Boost Earnings Per Share (EPS): By reducing the total number of outstanding shares, the profit is divided among fewer units.
• Distribute Surplus Cash: It is an efficient way to return capital to shareholders when the company has no immediate expansion plans.
• Support Share Prices: It provides a “floor” to the stock price during periods of high market volatility.
• Optimize Capital Structure: It helps in reaching a more efficient balance between debt and equity.
• Provide Exit Liquidity: It offers shareholders an opportunity to sell their holdings, often at a premium to the market price.

2. Statutory Sources of Funding

A company can only fund a buyback from the following specific sources:

• Free Reserves: Retained profits that are otherwise available for dividends.
• Securities Premium Account: Funds collected when shares were originally issued above face value.
• Fresh Issue Proceeds: Money raised from a new issue of a different kind of security (e.g., using proceeds from a preference share issue to buy back equity shares).

3. Essential Legal Conditions

The Act imposes strict “safety valves” to protect the company’s creditors and the economy:

• Authorization: The Articles of Association (AOA) must explicitly permit the buyback.
• Approval Thresholds:
  • Up to 10% of total paid-up equity capital and free reserves: Requires only a Board Resolution.
  • Up to 25% of total paid-up capital and free reserves: Requires a Special Resolution passed by shareholders.
• Quantity Limit: The buyback of equity shares in any single financial year cannot exceed 25% of its total paid-up equity capital.
• Solvency Mandate: The company must file a Declaration of Solvency with the Registrar of Companies (ROC) to prove it won’t go bankrupt within a year.
• Debt-Equity Ratio: The ratio of total debt to capital/reserves must not exceed 2:1 after the buyback is completed.
• Fully Paid Shares: Only shares that are 100% paid-up can be repurchased.

4. Permitted Modes of Execution

The buyback can be carried out through:

• Tender Offers: Purchasing from existing shareholders on a proportionate basis.
• Open Market: Buying shares directly through the stock exchange (common for listed companies).
• Employee Stock Options: Buying back shares previously issued to employees under ESOP or sweat equity schemes.

5. Mandatory Post-Buyback Compliance

Once the buyback is finalized, the following rules apply:

• Physical Destruction: The bought-back shares must be “extinguished” and physically destroyed within 7 days of completion.
• Cooling-off Period: The company cannot issue the same kind of shares for 6 months (except for bonus issues or fulfilling existing conversion obligations).
• Capital Redemption Reserve (CRR): If the buyback uses free reserves or securities premium, an amount equal to the nominal value of shares must be transferred to the CRR account to maintain the capital base.

Conclusion

A share buyback is a powerful financial tool. When executed within the legal boundaries of the Companies Act, it strengthens the balance sheet and signals management’s confidence in the company’s future.