Buyback of Shares Meaning, Procedure and Taxation Explained

Published on Tuesday, April 20, 2021 by Chittorgarh.com Team

Best Online Trading Account

We can help you find the right broker and save upto 90% in brokerage fees.

NamePhone
EmailCity
State
Are you a day trader?
Buyback of Shares Meaning, Procedure and Taxation Explained

Buyback of shares in India is a relatively new concept and has started gaining momentum recently. The buyback of shares is governed by SEBI (Buyback of Securities) Regulations 1998 that lays down the guidelines for the buyback process. The 1998 regulations have recently got replaced with SEBI (Buyback of Securities) Regulations, 2018. In this article, let us discuss the meaning of buyback of shares, reasons, methods, benefits, and much more.

Buyback of shares meaning

A buyback of shares is buying back of own shares by a company that was issued earlier. It is a corporate action event wherein a company makes a public announcement for the buyback offer to acquire the shares from existing shareholders within a given timeframe. The buyback of shares is also known as a stock buyback or repurchase of shares. The company announces an offer price for the buyback that is generally higher than the current market price.


Buyback of shares reasons

Recently, we have seen a spur in the buyback offers by the company. Do you know why do the companies buy back stock that was once issued by them? There are several reasons associated with it that urge a company to announce a buyback.

  1. Undervalued stock

    This is one of the main reasons why companies opt to buy back their shares. When the management feels that their stock is undervalued, they adopt the buyback route to rectify the stock price. The stock buyback reduces the number of shares in the market and thus gives a price boost to the remaining shares in the market.

  2. Excess Cash with not many project opportunities

    A company with free reserves in hand but not many project opportunities would prefer to go for a buyback. The company would use the cash to reward the shareholders rather than keeping it idle in the bank account over the required amount.

  3. Tax-efficient method of rewarding shareholders

    The dividends get taxed at two levels. First, at the company level and a second time in the hands of the shareholders. However, in the case of a buyback, only the company is liable to pay a buyback tax. The capital gains tax on the income from the buyback of shares is exempted for the investor. Thus, buybacks prove to be a more tax-effective way of distributing rewards to the shareholder.

  4. Strengthen promoter holding in the company

    The company promoters can increase its stake in the company by forfeiting the buyback offer. This strengthens their hold over the company and acts as a defense strategy in the case of hostile takeovers.

  5. To achieve optimum capital structure

    The capital structure of a company gets represented by its debt-equity ratio. Each industry has a different capital structure requirement. Some industries may not be suitable to rely on more debts, whereas some other business models may require large debts to run their business. Thus, as per the company requirement, a company may opt for buyback as a tool and repurchase its equity from the market to achieve an optimum capital structure.

In India, the buyback is done only through the extinguishing of shares. However, in other countries, buyback is also done to reward employees. The company buys back the shares from the public and distributes them to employees as ESOP. It helps avoid dilution of existing shareholding and compensates employees without any fresh issue of shares.


Buyback of shares methods

SEBI Buyback Regulations prescribe three methods of buyback of shares in India. A company can buy back the securities through any one of the following modes:

  1. Buyback of shares through tender offer

    In a tender offer, the company buys back its shares from the existing shareholders at a fixed price on a proportionate basis within a given time frame. The company issues a letter of offer and Tender Form to all the eligible shareholders on the company records as on the buyback record date. All the eligible shareholders who hold the shares either in physical form or Demat can participate in the buyback offer.

  2. Buyback of shares through open market

    In the case of buyback of shares from open market, a company can do so either through the stock exchange or the book-building process.

    In the case of buyback from the open market through the Stock Exchange mechanism, a company can buy back the shares only on the stock exchanges having nationwide trading terminals via an order matching mechanism. The promoters are not allowed to participate in the open market offers through the stock exchange. All other shareholders holding Equity shares of the company can participate in this offer.

    In the buyback through the book-building process, the buyback gets routed through electronically linked bidding centers. The company appoints a merchant banker to handle the buyback procedure. The merchant banker and the company determine the buyback price based on the response received for the buyback.

  3. Buyback of shares from Odd-lot holders

    In the case of buyback from the odd-lot holders, the company buys directly from the odd-lot shareholders by approaching them. An odd lot holder is a shareholder with shares lesser than the marketable lots as specified by the stock exchange. This method of the buyback is less common in India.


Buyback through Tender Offer Route Vs Buyback through Open Market Offer route

Of all the above methods listed, the tender offer and open market offer through the Stock Exchange mechanism are the most popular in India. Below are some of the specific characteristics of both the methods

 

Tender Offer

Open Market Offer Through Stock Exchange

Eligibility

All eligible shareholders as on a record date can participate in the tender offer.

There is no concept of the record date in the open market offer. All shareholders can participate in this type of buyback offer.

Ratio of Buyback

The buyback is done on a proportionate basis as per the buyback ratio. The additional shares tendered over and above the prescribed buyback ratio get accepted if there are any unaccepted shares.

There is no concept of ratio per shareholder. A shareholder can sell all of its shares till it is within the maximum buyback size announced by the company.

Buyback of shares timeline

A tender offer can remain open for ten working days

An open offer through the stock exchange can remain open for a maximum period of six months

Offer Price

A tender offer is a fixed price buyback offer.

The company announces the maximum offer price. The buyback can happen at a price lower than it based on order matching.

Letter of Offer

Mandatory in case of tender offer.

Letter of Offer not required. Only a public announcement is enough.


Buyback of shares procedure

A buyback of shares is a corporate action event in which a company purchases its shares from the existing shareholders either via a tender offer or from the open market. A buyback of shares can be out of company free reserves or the securities premium account. Below is the generic buyback process.

  1. As a first step, a company approves the buyback proposal in a board meeting.
  2. Post that, the company makes a public announcement for the buyback. The buyback announcement mentions the mode of the buyback.
  3. The company then files a letter of offer with SEBI in case of a tender offer.
  4. Interested shareholders approach their stockbrokers to tender their shares for buyback or put their bid for buyback in case of an open market offer.
  5. The stockbrokers then submit the tender forms and other specific documents like physical share certificates to the company registrar in case of a tender offer.
  6. The registrar verifies the tender forms and informs the exchanges on acceptance/non-acceptance of the tendered Equity shares.

    (i) The non-accepted shares get returned to the shareholders.

    (ii) The acceptance of the shares in an open market offer happens on order matching and gets executed on relevant pay-out dates.

  7. Once the shares get accepted, the shareholder receives the cash in return for the shares offered in the buyback.
  8. Lastly, the securities purchased in buyback are destroyed/extinguished by the company.

Impact of Shares Buyback

A share buyback has various impacts on a company's financial and other aspects.

  • Increase in Earning Per Share

    With the buyback of shares, the total number of outstanding shares in the market reduces. With earnings remaining the same and the number of Equity Shares reducing, the Earning Per Share (EPS) ratio shows a significant improvement.

  • Boost in Share Price

    The buyback generally has a positive impact on share prices. The buyback of shares will increase stock price. The buyback would shrink the supply of shares in the market on one side. On the other hand, with an increase in the EPS, people would prefer to buy the stock leading to a sudden demand for such securities. With higher demand and lesser supply, the prices of the shares get boosted.

  • Improvement of Financial Statements

    The buyback of stock will also have a positive impact on the financial statements reflecting an improved return on asset (RoA) and return on Equity (RoE) with a reduction in assets by way of reduced cash holding used to buy back the stock and a reduction in the number of Equity shares with the repurchase of shares.

  • Increase in Shareholder Value

    With the reduction in the number of equity shares in the market, the percentage of ownership held by each shareholder increases leading to an increase in the shareholder value.


Buyback of shares advantages and disadvantages

The buyback of shares has various advantages and disadvantages that impact the company and the shareholders. Let us have a look at each of them.

Buyback of shares benefits

  • Buybacks boost the share prices rectifying the prices of undervalued stocks.
  • Buybacks improve the company's Key Financial Ratios like Earning Per Share, Return on Equity, Return on Asset.
  • Buyback works as an alternative mode of reduction in capital without requiring approval from National Company Law Tribunal or Court.
  • Buyback serves as a financial engineering tool to optimize the capital structure of the company.
  • Buyback is a defense strategy to prevent hostile takeovers.
  • Buyback provides an easy exit route for shareholders for undervalued stocks.
  • Buyback helps optimum utilization of free cash with not many options of investment.
  • Buyback serves as a health check on the company's financial position as only the companies with good liquidity position are allowed to announce buyback offers.

Buyback of shares disadvantages

  • The improvement in the financial ratios of the company may not be real. The increase may be due to a reduction in the denominator on account of a decrease in the number of equity shares and assets. However, that may not be a real profit.
  • Possibility of diversion of excess cash for buyback rather than a productive investment opportunity,

Buyback of shares taxation

The buyback of shares is a tax-effective way of rewarding the shareholders for the company and the shareholders. The company is required to pay tax @ 20% on the buyback issue amount of shares. The income on the buyback of shares gets taxed as capital gains in the hands of the shareholder. These capital gains taxes are now no longer applicable to the investors.


Conclusion (Buyback of shares good or bad?)

The buyback of shares can be good or bad based on various factors. One should not just get lured by the premium price offered by the company. One should also consider other aspects like the necessity of buyback, the company's future growth prospects, individual goals, holding capacity, and risk appetite before deciding whether one wants to stay invested in the shares or wants to offer their securities in the buyback.

Frequently Asked Questions

  1. 1. What is buyback of shares?

    Buyback of shares is a corporate action event wherein a company purchases its own stock from the existing shareholders at a price higher than the current market price. The buyback of shares in India is generally done either through a tender offer or an open market offer through the Stock Exchange.

    The buyback of shares also known as Shares repurchase, allows a company to strengthen the promoter holding, utilize the free cash reserves optimally by rewarding the shareholders, and achieve the optimum capital structure.

     

  2. 2. Why buyback of shares is done?

    The buyback of shares is beneficial to a company as well as the shareholders. A company announces a buyback on account of various reasons stated below:

    1. The buyback helps a company to boost the share prices of their undervalued stock.
    2. The surplus cash returned to shareholders via buyback helps boost the shareholder's value and confidence.
    3. The buyback acts as a finance reengineering tool to achieve the optimum capital structure.
    4. The buyback helps increase the promoter's stake and thus acts as a defense strategy to protect them from the threat of hostile takeovers.
    5. The buyback allows shareholders to exit at a premium price as buybacks are offered at a price higher than the current market price.

     

  3. 3. Why would a company buyback its own stock?

    The buyback of shares allows a company to invest in itself and offers various benefits for such investment. A company opts for a buyback to avail the below advantages of purchasing its own stock.

    1. The buyback reflects a healthy financial status of a company.
    2. The buyback helps a company to consolidate its ownership.
    3. The buyback helps the share prices to boost. In the case of slow-moving markets, buyback helps support and preserve the stock value.
    4. The buyback tends to improve the Key financial ratios and enhance the shareholder value.
    5. The buyback is an effective way to utilize the ideal free capital that helps boost shareholder's confidence in the company.
    6. The buyback acts as a tool to achieve the optimum debt-equity ratio for a company by repurchasing the required equity from the market.

     

  4. 4. How will shareholders benefit from the buyback of shares?

    The shareholders also get to enjoy the benefits of a buyback as much as a company does.

    1. The buyback provides an opportunity to shareholders to exit at a price higher than the current market price.
    2. The buyback increases the percentage of shareholder's ownership in a company due to a reduction in the total number of outstanding shares.
    3. The buyback serves as a health check of a company's healthy financial position.
    4. The capital gains made in buyback are exempted from tax for the shareholders.

     

  5. 5. Who can participate in the buyback of shares?

    Two factors decide the eligibility of a person to participate in the buyback of shares:

    1. Whether the person is an existing shareholder; and
    2. Whether the shares are in Physical or Demat form.

    To be eligible to participate in the Tender offer buyback, a person needs to be an existing shareholder as on the Record Date of the buyback offer. In case of an open offer, any shareholder holding the shares of that company during the buyback period can participate in the buyback offer.

    In the Tender offer, the shares can either be in physical form or Demat form. While in the case of an open offer, generally only the Demat shareholders can be a part of the buyback offer.

    Note: The buyback of physical shares in an Open offer requires the company to maintain a separate window for the buyback of physical shares and follow a set of guidelines, as stipulated by the exchange for the physical stock. Thus, to avoid this, not many companies allow the physical shareholders to participate in the open offer buyback unless their shares get dematerialized.

     

  6. 6. Can physical shares be offered in the buyback?

    A physical shareholder can participate in the Tender Offer. However, in the case of an open offer, a physical shareholder is generally allowed to participate only once their shares get dematerialized.

    The companies allowing physical shareholders to participate in an Open offer need to request the Exchange for a separate window for the Buyback of Physical shares. But not many companies opt for this route but allows only Demat shareholders to avail the open offer.

     

  7. 7. How buyback affects share price?

    A buyback generally has a positive impact on the share price and, the share price tends to rise once the buyback gets announced.

    The share price tends to rise due to the shortage in the supply of shares that gets created due to the shares repurchased by the company. Another reason for the increase in the price rise is the increased investor confidence in the company financials as only a company with healthy financial can announce a buyback.

    With a reduction in the number of outstanding shares and earnings remaining the same, the EPS also improves significantly, leading to a price rise.

     

  8. 8. How does buyback of shares work?

    A buyback of shares is an event where the company purchases its own stock. The buyback of shares in India is generally done using the below two modes:

    1. Tender Offer
    2. Open Market Offer through Stock Exchange mechanism.

    In a tender offer, the company offers to buy the stock at a fixed price from the existing shareholders that are on the company's records as of the record date. The tender offer involves a buyback ratio in which the company can buy back the stock from the existing shareholders. Even the physical shareholders can participate in the Tender offer by tendering their physical share certificates. A tender offer is generally open for ten working days.

    In an open offer, there is no concept of record date or buyback ratio. Any shareholder holding the company shares during the buyback period can participate in the buyback. Generally, only the shareholders holdings the stock in Demat form are allowed to participate in the open offer barring a few exceptions. The open offer buyback remains open for about six months.

     

  9. 9. How is buyback of shares done?

    Buyback of shares is done out of the free reserves of the company. As a first step, the company desiring to go for buyback needs to approve the buyback proposal in the board meeting and decide on the mode of the buyback.

    Post the buyback proposal is approved, the below sequence is followed to complete the buyback.

    1. The company makes the public announcement mentioning the mode of buyback.
    2. The company issues a letter of offer and Tender form. (applicable in case of a tender offer)
    3. Interested shareholders approach their stockbrokers to tender their shares for buyback or put their bid for buyback in case of an open market offer.
    4. The stockbrokers then submit the tender forms and other applicable documents to the company registrar and also places a bid in case of a tender offer.

      In case of an open offer, the stock broker places a sell order against the buy order placed by the company for the buyback.
    5. The registrar verifies the tender forms and informs the exchanges on acceptance/non-acceptance of the tendered Equity shares.

      The acceptance of the shares in an open market offer happens based on order matching and gets executed on relevant pay-out dates.
    6. The shareholder receives due consideration in return for the accepted shares.
    7. As the last step, the company destroys the shares purchased by them within a stipulated timeframe.

     

  10. 10. How buyback of shares can be made?

    The buyback of shares can be made through your stockbroker.

    The interested shareholders that are eligible to participate in the buyback offer need to approach their respective stockbrokers indicating the details of the shares that they want to offer in the buyback. The stockbroker, in turn, places an order on your behalf on the exchange platform. You get cash in return for the successfully accepted shares.

    Points to note:

    • The physical shareholders need to submit the physical share certificates along with required documents to the stock broker.
    • The acceptance of shares in the case of an Open offer is based on the order matching mechanism.
    • The acceptance/non-acceptance of shares in the case of a Tender offer is decided by the Registrar based on the details provided in the Tender form.

     

  11. 11. Is buyback of shares good?

    The buyback of shares is generally perceived as a good opportunity by the shareholders as it provides an easy exit route at a premium price. However, one should not view the buyback offers just by the price but should also understand the company goals, financials and then decide to participate in the buyback based on one's risk appetite and holding capacity.

     



Rate this article
0
0.0
Rating:Rated 0.0 stars

Vote Here ...

Comments

Add a public comment...








Search Chittorgarh.com:

Download Our Mobile App

Android App iOS App