Knowledge of exit options is a prerequisite of any credible investment strategy and investors of all shapes and sizes are clear about their exit options right from the time of making their investment. Buyback of shares has always been looked upon as an option for exit when other routes such as IPO or a third part sale fails. On the contrary, companies look to pay out their excess cash in many ways, one of them being by buying back of it’s shares. Buyback is a mechanism that enables a company to approach the existing shareholders to repurchase/buyback the shares they hold of the company. Buyback gives companies another window to restructure their capital requirements, allowing them to use capital more effectively.
Common reasons for a company to opt for buy-back of it’s shares
Increasing the valuation of a company by increase in earnings per share (EPS): Through a buyback, the Company can reduce the outstanding shares and the capital base. As the number of shares will decrease, EPS will automatically increase. This usually improves the value per share of companies which may be considered favourably by prospective investors.
Buy out shareholders when the company has surplus funds in reserves: When the company has surplus amount of reserves in place than is required, the company may try to buyout the shares of the shareholders who are no more required by the company since shareholding represents the ownership in the company. This strategy is mostly used to provide exit to willing investors and consolidate the cap table.
Increase promoter’s stake in the company and decongesting the cap table: In India, companies are mostly promoter driven, family run and closely held. Promoters usually have significant shareholding in the company which they have formed/running. Option of buyback can be used to decrease the shareholding of non-promoters or similar groups by giving them an attractive price to avoid the potential takeover of the company and increase the promoters’ holding, leading to increased decision-making capacity. Buy-back can also help a company to clean up a cap table which might otherwise look overcrowded to potential investors.
Acts as an option to effect the implementation of Leaver clauses – Good or Bad: Depending on a good leaver or bad leaver situation, if individual shareholders are unable to buy out the shares of an exiting employee, the Company can use buy-back as a tool to re-purchase the shares from such an employee.
More cash in the accounts against few projects: When a company has enough cash reserves in its account and does not have immediate investment plans, then a lucrative option available for the company is to buyback the excess shares which are in the market and settle down rather than paying such shareholders dividends when the company has few projects to invest in.
Restructuring of the capital: Buy-back empowers the company to reduce the paid-up capital. It can be used as a tool for various restructuring activities.
Regulatory provisions governing buy-back in India for the private companies
A buy-back should conform to the guidelines as per Section 68 of the Companies Act, 2013 read with the Companies (Share Capital and Debentures) Rules, 2014, in case of private companies and also with (Buy-back of Securities) Regulations, 2018 for listed companies. Common sources of buy-back includes free reserves, securities premium account or proceeds of any shares or other specified securities. However, buy-back of any kind of shares or securities should not be made from the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.
Limits under Buy-back
A Company can buyback upto 25% of the total paid-up capital and free reserves by way of a shareholder’s approval and only 10% of total paid-up equity capital and free reserve in a single financial year. Further, buy-back of equity shares by a company in any financial year cannot exceed 25% of its paid-up equity capital. Below is a simple illustration to explain the calculation:
ABC Private Limited wants to buyback 5,00,000 fully paid-up equity shares of face value of INR 10/- each, at the price of INR 100/- per equity share, aggregating to INR 50,00,000 from its existing shareholders. What is the quantum of its shares that ABC Private Limited can buy-back from the existing shareholders?
Following are the basic details as per the financials available as on March 31, 2020:
Paid up capital of the Company – INR 50,00,000/-
Free Reserves – INR 1,00,00,000/-
Securities premium account – Nil
10% of paid up equity capital and free reserves with the approval of the Board aggregates to INR 15,00,000/-. However, 25% of the equity paid up capital comes to INR 12,50,000/-. Therefore, the Company can buy-back up to INR 12,50,000/- of equity share capital only.
ABC Private Limited can buy back a maximum of 25% of paid up capital and free reserves with the approval of the shareholders i.e. aggregating to INR 37,50,000/-. However, 25% of the equity paid up capital comes to INR 12,50,000/-. Therefore, the Company can only buy-back equity share capital amounting to INR 12,50,000/- even after obtaining approval of shareholders.
Limits for preference share capital that can be bought back in a financial year by a Company
Interestingly, as per Section 68(2)(c) of the Companies Act, 2013, it is provided that the 25% limit shall be construed with reference to the total paid up equity capital. It refers to the maximum number of equity shares that could be bought back. There are two limits up to which buy-back may be resorted (i) the over-all limit is restricted to 25% of the company’s paid-up capital (i.e. equity and preference share capital) and free reserves, and (ii) buy-back of equity shares in any financial year shall not exceed 25% of its paid-up equity capital.
Thus, for instance, while more than 25% of the equity shares cannot be bought back in any financial year, 100% preference shares may be bought back in a financial year subject to the upper limit of 25% of the company’s paid-up capital. Further, both equity shares (up to 25%) and preference shares (up to 100%) may be brought back in the same financial year so long the over-all limit (25% of paid-up capital and free reserves) is not exceeded.
Practical challenges and points to be mindful of while undertaking a buyback
Despite buyback being one of the popular ways of reducing the capital of Company, there are few practical challenges in undertaking such an option:
Limit for buy-back of shares in providing full exit: Considering the companies will not be allowed to buy-back more than 10% of the company’s paid-up capital and free reserves with approval of the board and more than 25% of the company’s paid-up capital and free reserves with approval of shareholders, it would difficult for the companies to use this as an option for providing complete exit to shareholders or investors of the company. Considering the difficulties, usually buy back will be coupled with other actions such as capital reduction etc.
Importance of a valuation report and valuation price of shares: The Company is required to valuate the price of the shares of the company being bought back. Further, the price per share being bought back from foreign shareholders cannot not be more than the fair market value of the Company. Hence, it is important to procure the valuation certificate well in advance to initiate the buy-back of shares. It is pertinent to note that the Companies Act, 2013 does not mandate for a valuation certificate if shares are being contemplated to be bought back from residents.
Reducing the offer period below 15 days: The offer for buy-back is required to be kept open for a period of not less than fifteen days and not exceeding thirty days from the date of dispatch of the letter of offer to the shareholders. However, with the consent of all the members, the offer for buy-back may remain open for a period less than fifteen days. This will, in most of the case where the number of shareholders is high, lead to practical difficulty in obtaining consents from all the members of the company for keeping offer period open for less than 15 days.
Offer letter to be circulated only after filing with the Registrar of Companies (“RoC”): Often it has been seen that Companies circulate the buyback offer letter to all the shareholders immediately after passing the resolutions without filing the same with the relevant RoC. This has led to serious complications at a later stage as the law mandates that the offer letter needs to be filed first with RoC and only then be circulated. However, such circulation is not dependent on the approval of the eform with the RoC.
Certain other restrictions in case of buyback:
- Consideration for Buyback can only be paid in cash;
- The company cannot issue any specified securities including bonus shares, till the date of closure of the offer;
- The company cannot withdraw the offer once it has announced the offer to the shareholders;
- The company cannot utilise any money borrowed from Banks/ Financial Institutions for the buy-back of shares; and
- No offer of buy-back can be made within a period of one year reckoned from the date of the closure of the preceding offer of buy-back.
Imprisonment provision for any non-compliance of the process and regulations under the Companies Act, 2013: Since the penalty for non-compliance with the provisions of the buy-back of shares is quite high and attracts imprisonment as well, keen attention towards each provision is required.
Tax implication on a buy-back exercise: The consideration paid by the company for purchase of its own unlisted shares which is in excess of the sum received by the company at the time of issue of such shares (distributed income) will be charged to tax and the company would be liable to pay additional income-tax at the rate of 20% (exclusive of surcharge and cess) of the distributed income paid to the shareholders. The tax on distributed income is to be paid by the Company even if there is no income tax on the total income of the domestic company computed in accordance with the provisions of the Income Tax Act, 1961.
Foreign Exchange Management Act (“FEMA”) & Regulations
Eligibility criteria under FEMA: When a company buys back securities from its foreign shareholders, NRIs, FIIs, etc., then the FEMA Regulations would apply. The key conditions to be fulfilled in order to avail the automatic route of transfer are as follows:
- the company must be eligible for automatic route investment under the FDI policy, i.e., it must not be in a restricted sector;
- the pricing guidelines specified by the Reserve Bank of India (“RBI”) are adhered to;
- Form FC-TRS along with the relevant annexures is filed with the Authorised Dealer (“AD”);
- this route is not available for companies operating in the financial service sector, e.g., banks, insurances, NBFCs, etc.
Sensitivity on documents to be submitted with, the AD: Generally, the ADs take uncompromising approach while approving the form FC-TRS in case of buy-back of shares from non-residents. ADs ensure the form is accurate and requires various documents for their review including the following (other than the regular documents which will be required for FC-TRS purpose):
- Acknowledgment/approval of form FC-GPR in case such non-resident acquired the shares in Indian company by way of subscription of shares along with compounding applications, if any, filed with Reserve Bank of India, along with acknowledgements thereof;
- Acknowledgment/approval of form FC-TRS in case such non-resident acquired the shares in Indian company by way of purchase of shares bay way of secondary sale along with compounding applications, if any, filed with RBI, along with acknowledgements thereof;
- Terms and conditions in case preference shares were issued to such non-residents;
- In case of conversion of preference shares into equity shares, the reporting for conversion and respective resolutions passed by the board of the company;
- Proof of outward remittance of consideration money;
- Form 15 CA;
- All the resolutions passed by the board and shareholders of the company in connection with buy-back of shares; and
- Any other documents as may be required by AD case to case basis.
Common issue faced in RBI reporting: In addition to the long list of documentation required for the purpose of FC-TRS reporting, considering that the responsibility of reporting of the form FC-TRS lies with the resident buyer/seller, the company buying back the shares will need to ensure that the reporting is done within the stipulated timelines to avoid the payment of late submission fees as may be levied by the RBI.
In the cases where the number of shareholders from whom the shares have been bought back are significantly high in numbers, it would be practically difficult for the company to file and get all the forms FC-TRS approved within the statutory timelines. It needs to be kept in mind, while the pay out for buy-back would have happened from the same bank account but different FC-TRS’s would need to be filed for different shareholders.
Despite several challenges and practical difficulties, buy-back is still a preferred route for providing exit to Investors and other corporate restructuring actions. In current scenario, since it is an alternative mode of reducing capital without requiring approval of the National Company Law Board Tribunal, corporates are choosing this mode coupled with other corporate actions to achieve the desired goal. In the first half of 2019, more than 70 big companies have opted for buy-back, including software exporters like Wipro, which announced a Rs 35,460 crore worth of share buyback. In the past 3 years, buy-back has supported various corporates in structuring their share capital, helped improve the earning per shares, allured and also provided exits to Investors at all levels.
This material and the information contained herein prepared by Algo Legal is intended to provide general information on a subject or subjects and is not an exhaustive treatment of such subject(s). Algo Legal is not, by means of this material, rendering professional advice or services. The information is not intended to be relied upon as the sole basis for any decision. Algo Legal shall not be responsible for any loss whatsoever sustained by any person who relies on this material.
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