What are share buy backs?
Share or stock buybacks are when the company that has issued shares buys them back from the shareholders. The company doing the share buyback has to pay market value for each share. In purchasing the shares, the company can buy the shares on the open market or from the shareholders directly. There are a number of reasons for why companies conduct share buy backs. Keep reading this article to find out more about share buy backs.
Rules and regulations
Depending on the amount of shares the company is trying to buy back, different rules are in place. The rule that applies depends on whether shares purchased is less than 10% of the total shares over a twelve month period. If it is greater than 10%, the stricter rule kicks in. This rule is the 10/12 limit and can be found in the Corporations Act 2001 at s 257 B(4).
Types of share buy backs
Equal access buy backs
Equal access buy backs are the most straightforward type of buy back. This type of buy back requires that the offer between ordinary shareholders is relatively the same with only slight differences between offers. These differences could be in the form of differing dividend entitlements or the calculation of odd lots. Odd lots just mean when an investor buys shares at an unusual amount. Instead of increments of 100 it would be a random number.
As we talked about earlier, the 10/12 limit places greater restrictions if above the limit. For equal access buy backs, if it is over the limit then you would need a majority vote from the shareholders to conduct it. If below the limit the company doesn’t need to get shareholder approval.
Selective buy backs
Selective buy backs are unique in the way that unlike equal access buy backs do not involve identical offers. With selective buy backs the company has the power to only offer to purchase shares from some shareholders. Selective buy backs need approval from all shareholders or by a special resolution. Special resolutions require 75% of the members to vote for the buy back. To eliminate bias, shareholders that are selling if the selective buy back gets the go ahead, aren’t allowed to vote in the special resolution. Interestingly enough, the 10/12 limit does not apply to selective buy backs, unlike equal access.
On-market buy backs
On-market buy backs are exactly what its name suggests. A company doing an on-market buy back simply buys their shares from the stock exchange. This requires an ordinary resolution to be passed if over the 10/12 limit and is subject to the rules of the stock exchange.
Employee share scheme buy backs
Employee share scheme buy backs are when the company buys the shares held by their employees or salaried directors. Like the equal access and on-market buy backs, if the amount of shares being bought is above the 10/12 rule, an ordinary resolution would need to be passed.
If you are thinking about selling your shares in a buy back or in charge of running a company and thinking about commencing a buy back, you should seek legal advice.
Purpose of buy backs
There are three main reasons a company would want to buy back their shares.
These are to:
- consolidate ownership
- increase equity value
- attract investors
Consolidate ownership
If you think about each share representing a percentage of the ownership of the company, a company could potentially have hundreds of thousands if not millions of owners. Whilst issuing shares in the beginning helps companies to receive capital and grow, after a certain amount of growth, sharing ownership with that many people can become troublesome. If the funds that were gained from issuing the shares is unused because there is no more room to expand, the company ends up losing money because of the dividends they need to pay to the shareholders. Instead of constantly paying out money to shareholders for money the company isn’t even using, it is much better to buy the shares back.
Increase equity value
Buybacks can increase or preserve the value of the share price. During a recession money becomes tight and it may not be viable for companies to continue paying the same rate of dividends to their shareholders. Buybacks can enable companies to continue paying the same amount of dividends. By purchasing the shares back they now have less to pay in dividends. Instead of paying dividends for 100,000 shares, if the company buys back 30,000 they will only need to pay dividends for 70,000. Although losing capital by purchasing these shares back, there is no longer a need to pay dividends for 30,000 shares. If the company is not comfortable with paying dividends for 100,000 shares but has enough money for 70,000 the share price of the company will be kept more intact.
Buybacks are used to increase the share price of a company if undervalued. For example, imagine a company believes that their shares are undervalued. Here the company can do a buyback to collect the shares only to reissue them at the price the company thinks fit. By doing this the share price increases. However it is risky if the company is wrong in their evaluation. Click here to learn more about undervalued stocks and the factors that affect value.
Attract investors
A company commencing a buy back automatically increases their earnings per share ratio (EPV). The ratio is calculated by dividing the earnings by the amount of outstanding shares. By reducing the amount of outstanding shares the EPV increases because the earnings are divided by a smaller number. A larger EPV looks better for investors because it signals that the company is earning a lot more despite the company not having increased in earnings.
Conclusion
Share buy backs are a nifty way for companies to regain ownership, increase/maintain their share price, and become more appealing to investors. For each type of buy back there is generally a more stringent requirement if the company goes over the 10/12 limit. Generally the most common added requirement imposed by the 10/12 limit is the need for an ordinary resolution to be passed.
