What is Buyback of Shares:
A Detailed Explanation:- A buyback of shares, also known as a share repurchase, is a corporate action where a company repurchases its own shares from existing shareholders, usually at a price higher than the current market price.
This process reduces the number of shares available in the open market and can have significant financial and strategic implications for the company and its shareholders. In India, buybacks are governed by the Companies Act 2013, and regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Buy-Back of Securities) Regulations, 2018. Below is a detailed, systematic, and plagiarism-free explanation of the concept, tailored to Indian standards.
1. Definition of Buyback of Shares
A buyback of shares refers to the process by which a company purchases its own outstanding shares from shareholders, either from the open market or through a direct offer. The repurchased shares are either cancelled (reducing the total share capital) or held as treasury shares, depending on the regulatory framework. The primary objective is to optimize the company’s capital structure, enhance shareholder value, or achieve strategic goals.
2. Objectives of a Share Buyback
Companies undertake buybacks for various reasons, including:
- Enhancing Shareholder Value: By reducing the number of outstanding shares, the Earnings Per Share (EPS) increases, potentially boosting the stock price.
- Optimizing Capital Structure: Buybacks help companies return excess cash to shareholders, especially when there are limited investment opportunities.
- Preventing Undervaluation: When a company believes its shares are undervalued in the market, a buyback signals confidence in future growth, supporting the share price.
- Tax Efficiency: In India, dividends attract Dividend Distribution Tax (DDT) (until its abolition in 2020) and income tax for shareholders. Buybacks, however, are taxed differently, often making them a more tax-efficient way to distribute surplus cash.
- Control and Ownership: Buybacks reduce the number of shares in circulation, increasing the promoter’s stake and reducing the risk of hostile takeovers.
- Utilizing Surplus Cash: Companies with excess cash reserves that are not required for immediate business needs may use buybacks to return capital to shareholders.
3. Legal Framework for Buyback in India
In India, share buybacks are regulated by:
- Companies Act, 2013: Sections 68, 69, and 70 outline the provisions for buybacks.
- SEBI (Buy-Back of Securities) Regulations, 2018: These apply to listed companies and provide detailed guidelines on the process, methods, and compliance.
- Income Tax Act, 1961: Governs the taxation of buybacks for both the company and shareholders.
Key Legal Requirements:
- Sources of Funds: A buyback can be funded using:
- Free reserves (e.g., retained earnings).
- Securities premium account.
- Proceeds from the issue of fresh shares or other specified securities (not from borrowed funds for this purpose).
- Limits on Buyback:
- The buyback must not exceed 25% of the aggregate paid-up capital and free reserves in a financial year.
- For listed companies, the buyback of equity shares in a financial year must not exceed 25% of the total paid-up equity share capital.
- Debt-Equity Ratio: Post-buyback, the company’s debt-equity ratio must not exceed 2:1 (except in cases approved by the central government).
- Board or Shareholder Approval:
- A buyback up to 10% of the total paid-up equity capital and free reserves can be approved by the Board of Directors.
- A buyback exceeding 10% but within 25% requires a special resolution from shareholders.
- Time Restrictions: After a buyback, a company cannot undertake another buyback for one year (cooling-off period).
- Prohibited Actions: Companies cannot issue new shares of the same class or withdraw the buyback offer once announced.
4. Methods of Buyback in India
Companies in India can execute a buyback through the following methods:
- Tender Offer:
- The company makes a direct offer to shareholders to buy back shares at a fixed price, usually at a premium to the market price.
- Shareholders tender their shares voluntarily within a specified period.
- This method is suitable for targeted buybacks and ensures equitable treatment of shareholders.
- Common for listed and unlisted companies.
- Open Market Purchase:
- The company buys its shares from the open market through stock exchanges at prevailing market prices.
- This method is flexible but may not guarantee a fixed number of shares.
- SEBI regulates the maximum price and timeline for open market buybacks.
- Odd Lot Buyback:
- Used to repurchase shares held in odd lots (small quantities) to reduce administrative costs and improve liquidity.
- Less common but allowed under SEBI regulations.
- Employee Stock Options (ESOPs):
- Companies may buy back shares issued under ESOPs, especially when employees leave the organization or the options lapse.
5. Process of Share Buyback
The buyback process in India typically involves the following steps:
- Board Approval: The Board of Directors passes a resolution to approve the buyback (for up to 10% of paid-up capital and free reserves) or recommends it to shareholders (for larger buybacks).
- Shareholder Approval: For buybacks exceeding 10%, a special resolution is passed in a general meeting.
- Public Announcement: For listed companies, a public announcement is made within 2 working days of the board/shareholder approval, disclosing the buyback details.
- Filing with SEBI: The company files a draft letter of offer with SEBI for approval (for listed companies).
- Offer Period: The buyback offer remains open for a specified period (usually 10-15 days for tender offers or up to 6 months for open market purchases).
- Execution: Shares are repurchased, and payment is made to shareholders.
- Extinguishment of Shares: Repurchased shares are cancelled within 7 days of the buyback completion (for listed companies).
- Reporting: The company submits a compliance report to SEBI and updates its records with the Registrar of Companies (ROC).
6. Taxation of Buyback in India
The tax implications of a buyback depend on whether the company is listed or unlisted:
- For Unlisted Companies:
- The company pays a Buyback Tax under Section 115QA of the Income Tax Act at 20% (plus surcharge and cess) on the distributed income (buyback price minus the issue price of shares).
- Shareholders are exempt from tax on the proceeds received from the buyback.
- For Listed Companies:
- The buyback tax regime applies similarly to unlisted companies, with the company bearing the tax liability.
- Shareholders do not pay capital gains tax on the buyback proceeds.
- Capital Gains for Shareholders (Pre-2013): Before the introduction of the buyback tax, shareholders were liable for capital gains tax (short-term or long-term) based on the difference between the buyback price and their cost of acquisition.
7. Advantages of Buyback of Shares
- Improved Financial Ratios: Reduction in outstanding shares increases EPS and Return on Equity (ROE).
- Market Confidence: Signals strong financial health and management’s belief in the company’s future prospects.
- Flexibility: Allows companies to return capital without committing to regular dividends.
- Tax Benefits: Buybacks can be more tax-efficient than dividends for shareholders in certain cases.
- Promoter Control: Increases promoter shareholding without additional investment.
8. Disadvantages of Buyback of Shares
- Reduced Capital Base: Cancelling shares reduces the company’s equity base, potentially limiting future growth opportunities.
- Market Perception: A poorly timed or executed buyback may signal that the company lacks profitable investment opportunities.
- High Costs: Buybacks at a premium can be expensive, reducing cash reserves.
- Regulatory Compliance: The process involves strict compliance with SEBI and Companies Act regulations, which can be complex and time-consuming.
- Shareholder Inequality: In open market buybacks, not all shareholders may participate equally, leading to potential discontent.
9. Impact on Stakeholders
- Shareholders: Benefit from higher EPS, potential share price appreciation, and tax-efficient returns.
- Company: Improves financial metrics but may face liquidity constraints or reduced flexibility for future investments.
- Market: Signals confidence, but excessive buybacks may raise concerns about growth prospects.
10. Recent Trends in India
- Increased Buyback of Shares Activity: Many Indian companies, especially in IT, FMCG, and pharmaceuticals, have undertaken buybacks in recent years to return surplus cash.
- Taxation Changes: The introduction of the buyback tax in 2013 shifted the tax burden from shareholders to companies, influencing buyback decisions.
- SEBI Reforms: SEBI has periodically updated its regulations to ensure transparency, protect minority shareholders, and prevent market manipulation.
Conclusion
A share buyback is a strategic tool used by companies in India to optimize their capital structure, enhance shareholder value, and signal financial strength. Governed by the Companies Act, 2013, and SEBI regulations, buybacks must comply with strict legal and procedural requirements. While they offer benefits like improved EPS and tax efficiency, companies must carefully weigh the costs and long-term implications. For shareholders, buybacks present an opportunity to realize value, but the decision to participate depends on individual financial goals and market conditions.