In this blog, we will delve into the intriguing world of Share Buybacks in India – exploring everything you need to know about this financial practice.
Share buybacks are gaining prominence as a strategic tool used by companies to bolster shareholder value and optimize their capital structures.
We’ll discuss the advantages of share buybacks, the legal and regulatory framework governing them, and how they compare to dividends.
Additionally, we’ll examine the pros and cons for investors to consider. By the end of this blog, you’ll have a comprehensive understanding of share buybacks and their significance in the Indian market.
What are Share Buybacks?
Share buybacks, also known as stock repurchases, refer to the practice of a company buying back its outstanding shares from the open market or existing shareholders.
In this procedure, the firm buys back some of the shares it has issued and removes them from the market. Thus, lowering the number of outstanding shares.
Share buybacks are a tactical financial maneuver used by businesses to maximize their capital structure. Also, to return excess cash to shareholders, and increase shareholder value.
The ownership of the firm is among fewer shareholders thanks to a decrease in the number of existing shares. This might raise the value of each share that remains.
Companies may buy back shares to express confidence in their ability to:
– Manage their finances and prospects.
– Reduce the impact of employee stock options dilution.
– Boost earnings per share (EPS) by dividing profits among fewer shares, among other reasons.
In many nations, share repurchases must abide by all applicable rules and laws. Depending on the jurisdiction and the particular regulations regulating such transactions, the procedure and requirements for performing share buybacks may change.
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Share Buybacks vs Dividends
Share buybacks and dividends are two common methods used by companies to distribute profits to shareholders.
While both serve the purpose of returning value to investors, they differ in their mechanics and impact on shareholders. Let’s compare share buybacks and dividends:
Share Buybacks: Companies engage in share buybacks to repurchase their outstanding shares from the open market or existing shareholders. They aim to reduce the number of outstanding shares, thereby increasing the ownership stake of existing shareholders and boosting the stock price.
Dividends: Companies distribute dividends as cash payments to their shareholders, usually on a per-share basis. The purpose is to provide a part of the company’s profits directly to shareholders as a reward for their investment.
Impact on Shareholders
Share Buybacks: Share buybacks can increase the value of each remaining share by reducing the number of outstanding shares. This leads to higher earnings per share (EPS) and may be seen as a signal of the company’s confidence in its future performance. However, it does not provide immediate cash to shareholders unless they sell some of their shares in the open market.
Dividends: Dividends provide direct cash payments to shareholders, which they can use as they see fit. It offers immediate income and liquidity to investors, making it an attractive option for those seeking regular income from their investments.
Share Buybacks: In some jurisdictions, shareholders may be subject to capital gains tax when they sell their shares after a buyback, depending on their tax situation and holding period. However, the tax implications of share buybacks can vary across different countries and tax laws.
Dividends: Dividends are typically subject to dividend tax, which can be at a different rate than capital gains tax. The tax treatment of dividends also varies based on the country’s tax laws and the individual’s tax bracket.
Signal to the Market
Share Buybacks: Share buybacks are often seen as a positive signal to the market, as they indicate that the company believes its shares are undervalued. This action may instill confidence in investors and may drive up the stock price.
Dividends: Regular payment of dividends can demonstrate financial stability and a consistent stream of income to investors. Companies with a history of stable dividends may attract income-focused investors.
Regulation and Framework
The legal and regulatory framework of share buybacks in India is governed by the Companies Act, of 2013, and the Securities and Exchange Board of India (Buyback of Securities) Regulations, 2018.
These regulations outline the procedures and guidelines that companies must follow when conducting a buyback of shares.
The company’s board of directors and shareholders must approve the buyback through a special resolution passed at a general meeting. The special resolution specifies the largest number of shares that can undergo buyback and the buyback price.
So, the companies can only use free reserves, securities premium accounts, or proceeds from the issue of any shares. They are not allowed to use borrowed funds to buy back.
After getting the necessary approvals, the company must make a public announcement about the buyback, publishing it in newspapers. Also, the announcement must include details such as the number of shares, the buyback price, the duration of the buyback period, and the objectives of the buyback.
The maximum number of shares that a company can buy back in any financial year is 25% of its total paid-up equity capital. Additionally, the buyback offer cannot exceed 15% of the aggregate of its paid-up capital and free reserves.
A company can choose between two methods of buyback: open market buyback and tender offer buyback. In the open market buyback, the company buys back shares from the stock market.
More about Regulation and Framework
In the tender offer buyback, the company makes an offer to its shareholders to buy back their shares at a specified price.
To proceed with the buyback, the company must open a separate bank account, known as the Escrow Account, to deposit the funds for the buyback. The company must deposit the amount equal to the buyback consideration in this account.
The buyback process should finish within 6 months from the date of passing the special resolution. During this period, the company must complete the buyback and extinguish the shares bought back.
Later, the company must file a return of buyback in the prescribed format with the Registrar of Companies (RoC) within 30 days. Also, the company should make necessary disclosures regarding the buyback in its financial statements.
Following the buyback, the company cannot make any further issues of the same kind of shares within six months. Except by way of a bonus issue or in the discharge of subsisting obligations such as conversion of warrants, stock options, etc.
Thus, compliance with these legal provisions and regulatory guidelines is essential for companies conducting a share buyback to ensure transparency, fairness, and protection of shareholders’ interests. Non-compliance may result in penalties and legal consequences for the company and its management.
Share Buyback Process in India
The share buyback process in India involves several steps and compliances that companies must adhere to. Here is an overview of the share buyback process:
The first step is for the company’s board of directors to approve the proposal for a share buyback. The board will assess the financial position of the company, its capital requirements, and the availability of free reserves to fund the buyback.
Once the board approves the buyback proposal, the company needs to seek approval from its shareholders. The passing of the resolution takes place at the general meeting, where shareholders vote on the buyback proposal. The special resolution specifies the maximum number of shares that will undergo buyback and their price.
SEBI and Stock Exchange Intimations
After obtaining shareholder approval, the company needs to make public announcements about the buyback. It must notify the Securities and Exchange Board of India (SEBI) and the stock exchanges.
Opening Escrow Account
The company must open a separate bank account known as the Escrow Account to deposit the funds for the buyback. The company deposits the amount equivalent to the buyback consideration in this account.
Buyback Offer Period
The company then proceeds to make the buyback offer to its shareholders. The offer period typically lasts for 15 days. During this period, shareholders can choose to tender their shares for buyback.
Verification of Tenders
After the offer period ends, the company verifies the tendered shares to ensure they comply with the regulatory guidelines and the terms of the buyback offer.
Acceptance of Shares
The company accepts the validly tendered shares and transfers the buyback consideration to the shareholders’ bank accounts.
Extinguishment of Shares
After completion of the buyback process, the company extinguishes the shares bought back.
Filing with ROC
Within 30 days of completing the buyback, the company must file a return of buyback with the Registrar of Companies (ROC) in the prescribed format.
After the buyback, the company cannot make any further issue of the same kind of shares for six months, except by way of a bonus issue or in the discharge of subsisting obligations.
Pros of Share Buybacks
- Increase in Share Value: By reducing the number of outstanding shares through buybacks, the earnings per share (EPS) and other financial metrics may improve, leading to an increase in the share price. This benefits existing shareholders.
- Efficient Capital Allocation: Buybacks allow companies to utilize excess cash for repurchasing shares. It is often viewed as a more tax-efficient way of returning capital to shareholders compared to dividends.
- Signal of Confidence: Share buybacks can signal management’s confidence in the company’s prospects. It shows that the management believes in the low value of the stock and that the company has enough cash flow to repurchase its shares.
- Prevent Dilution: Companies use buybacks to prevent the dilution of existing shareholders’ ownership. It is caused by the issuance of new shares for employee stock options or other purposes.
Cons of Share Buybacks
- Misallocation of Capital: Critics argue that some companies prioritize share buybacks over investing in research, development, or expansion, which may limit their long-term growth potential.
- Short-Term Focus: Buybacks may be a short-term strategy to boost share prices and appease shareholders, potentially sacrificing long-term investments that could create more value for the company.
- Market Timing Risks: Companies may end up repurchasing shares at inflated prices during market peaks, leading to poor returns for shareholders.
- Reduced Liquidity: Buybacks can reduce the number of outstanding shares, leading to lower trading volumes and potentially reduced liquidity in the stock.
- Financial Flexibility: Using excess cash for buybacks rather than retaining it for strategic acquisitions or unforeseen events may limit a company’s financial flexibility.
Share buybacks in India optimize capital structures, boosting EPS and shareholder value. They signal confidence in the company’s prospects, but critics warn of misallocation of capital and reduced long-term growth potential. Compared to dividends, buybacks offer tax efficiency and prevent dilution.
The legal framework, governed by the Companies Act, 2013, and SEBI (Buyback of Securities) Regulations, 2018, requires board and shareholder approvals, public announcements, and filing with the ROC.
Prudence is essential to balance short-term gains with long-term investments. A comprehensive understanding empowers investors and companies to make informed choices in the evolving corporate finance landscape in India.
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