A buy-back is when a company buys its own shares back from its shareholders. After the buy-back, those shares are cancelled. This is different from a shareholder selling shares to another person, because here the company itself is the buyer. Section 68 of the Companies Act, 2013 sets out the rules.
Where the money can come from
A company can fund a buy-back from three sources:
- Free reserves (reserves that are available for distribution as dividend)
- The securities premium account
- The proceeds of a fresh issue of shares made specifically for the buy-back
A company cannot use borrowed money for a buy-back, and it cannot use its capital. The source must fall within these three categories.
The debt-equity rule
After the buy-back, the company's debt must not be more than twice its equity. In other words, the post-buy-back debt-equity ratio must not exceed 2:1. This is a protective rule: the buy-back should not leave the company over-borrowed.
How many shares can be bought back
There are two routes:
- Board route: Up to 10% of the total paid-up equity capital and free reserves, with a board resolution.
- Shareholder route: Up to 25% of the total paid-up equity capital and free reserves, with a special resolution.
A company cannot buy back more than 25% of its paid-up capital and free reserves in a financial year. There is also a rule that a company cannot make a second buy-back within one year, unless it has exhausted the earlier offer.
The procedure
The company passes the board resolution or the special resolution, files Form SH-8 (letter of offer) with the ROC, and dispatches the offer to shareholders. Shareholders can tender their shares. After the buy-back, the company files Form SH-9 (declaration of solvency), SH-10 (return of buy-back) and SH-11 (extinguishment of shares). The shares must be extinguished within seven days of the buy-back.
What extinguishment means
Extinguishment means the shares are cancelled and cease to exist. The paid-up capital of the company reduces by the face value of the bought-back shares. The company must physically cancel the share certificates and update the register of members. If the buy-back was funded from free reserves or securities premium, an amount equal to the face value of the shares bought back must be transferred to the Capital Redemption Reserve Account.
The practical points
The company must check the debt-equity ratio before and after the buy-back. It must check that the shares are fully paid-up. It must ensure that the buy-back is completed within the prescribed time from the date of the board resolution. And it must file all four forms within the prescribed time, because a missing form is a common ROC objection.
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