Home / Business investment Articles / Investor Exit Strategy: Shareholder Buy-Back

investor exit strategy: shareholder buy-back

Basically, a shareholder buy-back is a process in which a shareholder or a company reacquires its own stock. The purchase of outstanding shares is done in a view to lower the number of shares on the market. In layman’s language a buy-back is similar to stock repurchase.

The main strategy related to buying back of shares is to boost the price of the current company shares floating in the share market. The main reason for a shareholder buy-back is decrease it would propel in the number of outstanding shares in the market, thereby increasing the demand and with the rise in demand, the share prices will again tend to shoot up. However, it is claimed that another reason behind a company or a shareholder resorting to buy-back is to waive off any kind of threats by shareholders who may be seeking for a controlling stake.

With a buy-back the remaining shareholders of the company own a boosted proportion of ownership of the company. A shareholder buy-back reflects that the company and its management own a positive attitude towards the company’s future.

Some countries such as U.S and U.K have a law that grants a firm the right to repurchase its own shares by giving money to the shareholders existing in the company. The return of the cash the company gets a proportion of the firm’s presently standing equity. In a nutshell, it can be considered as an exchange of money done in a view to lower the number of outstanding shares in the stock market.

Types of Shareholder Buy-backs:

Shareholder buy-back is broadly segregated into two categories; one is a specific category dealing with selective buy-backs. However, the second one is a cumulative category that involves other types less prevalent buy-backs.

Selective Shareholder Buy-backs:

Basically, a selective buy-back is a type of buy-back that involves the use of different offers for different shareholders. Besides, in most of the cases only a few are presented with the offer. Selective buy-back is possible if the scheme offered receives a nod from all the shareholders. The minimum majority required is 75 %, called a special resolution. However, under it no vote can be casted by selling shareholders or their associates. Besides, selling shareholders have the right of voting against a special resolution and disapprove a selective buy-back process. Prior to the meeting, a notice for the same is delivered to selective shareholders required to participate in the selective buy-back process. The notice includes a statement highlighting each and every detail required for the proposal.

Other types of Shareholder Buy-backs:

There are three more forms of buy-backs, however, are less prevalent in companies. A company has a right to buy-back shares that are owned by or for employees or directors of the company or a related firm. This form of buy-back is called employee share scheme buy-back. The process makes use of an ordinary resolution, unlike selected buy-back.

In addition, a company that has its shares listed in the stock exchange can also buy back its outstanding shares in on-market trading on the stock exchange. This comes under a form called on-market buy-back. However, this can be done an ordinary resolution passed is over 10/12 benchmark. Besides, a listed firm also possesses the rights to acquire those shares from its shareholders that are not permitted to float in the market. This buy-back process is called minimum holding shareholder buy-back. However, such shareholder buy-backs do not require a resolution, but the shares acquired are required to be annulled.

Ways by which a company can buy-back its own shares:

There are three feasible sources by which a company or shareholder can buy-back its own shares. These are:

  • One way can by with the assistance of existing shareholders. Here shares can be bought back on a proportionate basis while involving a tender offer.
  • Another way is to buy-back share from the open market itself. This can be done either through the Book building process or Stock exchange.
  • The third way is to resorting to odd lot holders.

Purpose of Shareholder Buy-back

A shareholder buy-back is always beneficial for the company as it indirectly raises the share prices. As a result, the company fetches some profit out of it. When a company fetches a profit, it has two ways to deal with it. One can be that the company can distribute a proportion of the net profit among its shareholders in form of dividends over their shares. Besides, the remaining profit is kept aside that can be used by the company for future capital investments. This profit is termed as stockholder’s equity. However, there are instances when a company cannot reinvest a part or the complete retained earnings in a view to yield robust returns.

A shareholder buy-back is deemed to be an effective way to utilize remaining retained profits. When a company indulges in reacquiring its own outstanding shares, it lowers the number of shares floating in the market. The reduction of float results in a rise in the earnings per share, with the net profits remaining the same.

There may be instances, when a firm’s management discerns that the company stock is trading below its minimum value. In such cases, the firm manager can seek to resort to a shareholder buy-back. Such an open market reacquisition of shares facilitates a robust and profitable investment for the manager. The manager can later re-issue them after a market correction and earn profit.

Another purpose backing executives attempt to buy-back shares is a bid to fulfill earnings per share target. Many executives are tired with an executive compensation so that he can meet robust earnings per share. Firms which witness a small amount of opportunities for organic growth, resort to such shareholder buy-backs.

In addition, another advantage posed by shareholder buy-back is that it serves as a way to eschew the accumulation of large amount of cash in the firm. Besides, companies with a robust cash yield and less spending are in a view to avoid the cash being reflected in their balance sheets as it can create fears of takeover.

Share buy-backs also enable companies to stealthily distribute their annual earnings among its investors without imposing any tax. However, such a process is officially viable where there is no imputation tax credit processes.