Buyback of Equity Shares

What is buyback of Equity Shares?

Buyback of shares is a method of financial engineering involving a material alteration in the equity structure of an organization. It's a procedure that enables a company to purchase its shares from its existing shareholders. The issuing company i.e. the Company buying back it's shares pay its shareholders, the market value per share for the number of shares bought back. In short, the company re-absorbs that portion of its ownership which was previously distributed among public and private investors.

Why buyback of equity?

A Company heads with buyback for the following reasons:

•  To  reduce the number of shares in circulation in order to improve / control the share price.

•  To return the resources to the shareholders which are no longer needed by the company.

•  To improve shareholder’s value, resulting in higher earnings per share (EPS).

•  To provide a safeguard against hostile take-over by increasing promoter’s holdings.

How is Buyback done?

1. BUYING FROM OPEN MARKET: The company can buy its own stocks from the market which can happen through company’s brokers. There is no obligation to necessarily conduct the buyback program after the announcement, hence allowing the company to cancel it. It can prove to be very cost effective.

2. FIXED PRICE TENDER OFFER: Under this method, the company makes an offer to buy a fixed no. of share at a fixed price. The price offered by the company is usually above the current market price so as t make the buyback attractive. The shareholders have the option to sell back the share or hold the shares. During the process, if total no of shares exceeds the shares required by the company, shares are bought back on a pro-rata basis. This method is quick but can prove costlier than buying shares back from the open market.

3. DUTCH AUCTION TENDER OFFER: Here, the company offers a range of prices to the shareholders where the minimum price is above the current market price. For example, a stock is currently trading at Rs. 100. The company offers to buy back 2 Cr shares within the range of Rs. 101 to Rs. 103. Investors will bid the no. of shares and the minimum price at which he/she wants to sell the shares. The company will start qualifying bids from Rs.101 and move to higher prices until requirement of fixed no. of shares is fulfilled. If at Rs. 102, the requirement of 2 Cr shares is fulfilled, every qualified bidder is paid Rs. 102. Bids above Rs. 102 will be rejected. If total bidding at Rs. 101 and Rs. 102 exceeds the requirement of shares then shares are allotted on a pro-rata basis.

4. REPURCHASE BY DIRECT NEGOTIATION: The company management personally approach only those shareholders who have a large block of shares. They are offered premium above the current market price. This method is more logical approach as the company can directly negotiate with large shareholders and eliminate their ownership.

Provisions of Buyback under Section 68 of Indian Companies Act, 2013

Section 68 of Companies Act, 2013 deals with the following compliances related to buy-back of equity shares.

1. Purchase can be made out of:

(a) its free reserves;

(b) the securities premium account; or

(c) the proceeds of the issue of any shares or other specified securities: 

No buy-back of any kind of shares or other specified securities shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.

2. Preliminary Conditions:

(a) A buyback must be must be authorized by its articles;

(b) A special resolution should be passed at a general meeting of the company authorizing the buy-back, but the same is not required when:

(i) the buy-back is 10% or less of the total paid-up equity capital and free reserves of the company; and

(ii) such buy-back has been authorized by the Board by means of a resolution passed at its meeting;

(c) The amount of total payment towards buy back of equity shares in a year shall not exceed the aggregate of 25% of the paid up equity capital and the free reserves of the company.

(d) Debt equity ratio should be 2:1

Where:

• Debt is aggregate of secured and unsecured debts owed by the after buy-back

• Equity: is aggregate of the paid-up capital and its free reserves.

(e) all the shares or other specified securities for buy-back are fully paid-up;

(f) If shares or securities are listed, buy back will be in accordance with the regulations made by the Securities and Exchange Board of India.

(g) No offer of buy-back shall be made within a period of one year from the date of the closure of the preceding offer of buy-back, if any.

3. Explanatory Statement:

• The notice of the meeting at which the special resolution is proposed to be passed shall be accompanied by an explanatory statement stating 

• Disclosure, necessity, class of shares, time limit, dates of board meeting, buyback method, offer price, maximum amount of buyback, etc. 

4. Time Limit:

Every buy-back shall be completed within a period of one year from the date of passing of the special resolution.

5. Options for Buy back:

The buy-back can be:

a)   from the existing shareholders or security holders on a proportionate basis;

b)   from the open market;

c) by purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

6. Solvency Declaration (Form SH-9):

A declaration of solvency to be signed by at least two directors of the company on Form SH-9 (http://www.mca.gov.in/MinistryV2/companyformsdownload.html) stating its capability of meeting its liabilities and will not be rendered insolvent within a period of one year from the date of declaration adopted by the Board.

7. Extinguishment of Certificate: 

The company shall extinguish and physically destroy the security certificates so bought back in the presence of a Registrar to issue or the Merchant Banker and the Statutory Auditor within fifteen days of the date of acceptance of the shares or other specified securities.

8. No further issue till 6 months: 

A company shall not make any further issue of the same kind of shares within a period of six months except by way of a bonus issue, conversion of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity shares.

9. Register to be maintained (Form SH-10):

The company shall maintain a register of shares or other securities which have been bought-back in Form No. SH10 (http://www.mca.gov.in/MinistryV2/companyformsdownload.html). This register shall be maintained at the registered office of the company and shall be kept in the custody of the secretary of the company or any other person authorized by the board on this behalf.  

10. Return of Buy Back (Form SH-11)

After the completion of the buy-back, a company shall file a return with the Registrar and the Securities and Exchange Board containing details relating to the buyback within thirty days of such completion. The return is subject to a fees starting from Rs. 200 based on nominal share capital and additional fees in case of delay.

Take a look: https://mca.gov.in/MCA21/dca/help/instructionkit/NCA/Form_SH-11_help.pdf

11. Punishment for any Default:

As per Section 68 (11) of Companies Act, 2013, If a company makes any default in complying with the buyback provisions, the company shall be punishable with fine from one lakh rupees to three lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term up to three years or with fine from one lakh rupees to three lakh rupees, or both.

12. Capital Redemption Reserves and Utilization:

A sum equal to the nominal value of the shares so purchased shall be transferred to the capital redemption reserve account. This reserve can be utilized to pay fully paid bonus shares.

Procedure for Buyback of Equity Shares

1. Notice of Board meeting has to be given – Minimum 7 days notice before Board meeting. 

2. In the board meeting, pass resolution for buy back, fix the date for Extra Ordinary General Meeting, approve notice for calling Extra Ordinary General Meeting with explanatory statements.

3. Send notice of EGM giving a minimum 21 days clear notice before the date of EGM.

4.  In EGM, pass special resolution approving the proposed amount of buyback of equity shares..

5. Within 30 days of EGM, file form MGT 14 with ROC. MGT 14 is filed after passing resolutions. 

6. After passing special resolution, Letter of Offer has to be filed in Form SH-8 with the ROC which shall be signed by minimum two directors, one of whom shall be the Managing Director, if any. 

7. Along with Form SH-8, Declaration of Solvency has to be filed with the ROC through Form SH-9,  signed by two directors , one of whom shall be the Managing Director if any.

8. Within 20 days from date of filing SH-8 with ROC, the Letter of Offer should be dispatched to shareholders. Offer shall remain open for minimum 15 days to maximum 30 days from the date of dispatch. 

9. Within 15 days from the date of closure of the offer, the shares or other securities lodged shall be deemed to be accepted unless a communication of rejection is made within twenty one days from the date of closure of the offer. 

10. A separate Bank account should be opened after closure of offer. 

11. In the bank account, deposit the total amount payable as consideration for the shares offered for buy back. 

12. Within 7 days of verification / acceptance, consideration to the respective shareholder should be paid in cash. 

13. Within 7 days from the last date of completion of Buy-Back, shares / securities bought back should be physically destroyed.

14.  After completion of buy back, Register of shares / securities bought back in Form SH-10 has to be maintained. 

15. Within 30 days of Completion of Buy-Back, Return of Buy-Back with ROC in Form SH-11 should be filed.

Journal Entries

I. If shares to be bought-back are not fully paid, then make a final call and make them fully paid. 

(A) Making of final call

Equity Share Final Call A/c ... Dr

To Equity Share Capital A/c 

(B) Receipt of final call amount

Bank A/c ... Dr

To Equity Share Final Call A/c

II. Sale of assets / investments to arrange cash for financing buyback.

Bank A/c ... Dr

To Assets or Investment A/c 

(Asset / Investment can be sold at profit or loss which will have a reflection in the profit and loss a/c under reserves and surplus)

III. Issue of Preference Share Capital / Debentures for financing buyback.

Bank A/c ... Dr

To Debentures A/c 

(The above transaction can be at premium or discount. In case of premium, credit Securities Premium A/c and debit Discount on Issue A/c in case of issue at discount.)

IV. Making Equity shares due for buyback (amount payable)

Equity Share Capital A/c ... Dr 

Premium on Buy-back of Shares A/c ... Dr (if applicable)

To Equity Shareholders A/c 

Note: If buyback is at discount, the discount amount is credited to capital reserve a/c.

V. Adjustment of premium on buyback

Securities Premium A/c ... Dr

Divisible profits A/c ... Dr

To Premium on Buy-back of Shares A/c

VI. Creation of Capital Redemption Reserve out of divisible profits. 

Divisible Profits A/c ... Dr (utilized)

To Capital Redemption Reserve A/c (created)

[CRR = Nominal Value of Buyback - Fresh Issue]

VII. Payment to Equity Shareholders

Equity Shareholders A/c ... Dr

To Bank A/c

Note: As per Rule 17 (8) of the Companies (Share Capital and Debentures) Rules, 2014, private companies and unlisted public companies are required to open a separate bank account and deposit the entire sum due and payable as consideration for shares tendered for buy-back. 

Entries are: 

Share Buy-back Bank A/c ... Dr

To Bank A/c 

Equity Shareholders A/c ... Dr 

To Share Buy-back Bank A/c

VIII. Issue of Bonus Shares out of CRR, Reserves and Securities Premium.

(A) Declaration of Bonus

CRR A/c ... Dr

Divisible Profits A/c ... Dr

To Bonus to Equity Shareholders A/c

(B) Issue of Fully Paid Up Bonus Shares

Bonus to Equity Shareholders A/c ... Dr

To Equity Share Capital A/c

Basic Examples on application of Journal Entries

Illustration 1

A company wants to buyback 5,000 equity shares of Face Value Rs. 10/- each at par. Pass journal entries for making Equity Shares due for buyback, creation of CRR and payment to equity shareholders.

Solution:

1. Equity shares due for buyback

Equity Share Capital a/c Dr..........................50,000

To Equity Share Holders a/c.....................................50,000

(Being 5,000 equity shares due for buyback at par)

2. Creation of Capital Redemption Reserve (assuming that CRR is created out of General Reserve)

General Reserve a/c Dr...............................50,000

To Capital Redemption Reserve a/c.....................50,000

(Being Capital Redemption Reserve created out of General Reserve to the extent of nominal value of buyback of equity shares)

3. Payment to equity shareholders

Equity Shareholders a/c Dr.......................50,000

To Bank a/c................................................................50,000

(Being payment made to equity shareholders)

Illustration 2:

A company wants to buyback 5,000 Equity Shares of Face Value Rs. 10/- each at Rs. 15/-. Pass journal entries for making equity shares due for buyback, creation of CRR, payment to equity share holders and adjustment of premium on buyback.

Solution:

As equity shares are being bough back at a price higher than the face value, the excess amount will be treated as premium. This premium is paid out of companies reserves.

1. Equity shares due for buyback

Equity Share Capital a/c Dr..........................50,000 [5,000 Shares X Rs. 10 FV]

Premium on Buyback ac Dr.........................25,000 [5,000 Shares X Rs. 5 Premium]

To Equity Share Holders a/c.....................................75,000 [Payable created towards equity shareholders] 

(Being 5,000 equity shares due for buyback at par)

2. Creation of Capital Redemption Reserve (assuming that CRR is created out of General Reserve)

General Reserve a/c Dr...............................50,000

To Capital Redemption Reserve a/c.....................50,000

(Being Capital Redemption Reserve created out of General Reserve to the extent of nominal value of buyback of equity shares [5,000 Shares X Rs. 10/- FV])

3. Payment to equity shareholders

Equity Shareholders a/c Dr.......................75,000

To Bank a/c................................................................75,000

(Being payment made to equity shareholders)

4. Adjusting Premium on Buyback (assuming that premium on buyback is adjusted against Securities Premium)

Securities Premium a/c Dr.......................25,000 [5,000 Shares X Rs. 5/- Premium]

To Premium on Buyback a/c................................25,000

(Being premium on buyback of Rs. 5/- per share adjusted against Securities Premium a/c)

Important Note: 

1. When buyback is done, Equity Share Capital and Reserves reduce from the Balance Sheet along with an equal reduction in the bank balance. This is how still the Balance Sheet tallies.

2. Like how every expenditure is charged against profits during normal course of business, under buyback, the premium on buyback is adjusted against divisible profits.

Computation of maximum number of shares to be bought 

One of the most prominent step while executing buyback is to analytically determine the maximum number of shares that can be bought back by the company based on available resources. Here, the directors, investment banker and the concerned chief officers work out calculations to derive the maximum possible number of shares that the company can buyback. Moreover, determining offer price is also a vital task and here we will understand how to determine both. 

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