Share Buybacks and Common Mistakes

There are a number of potential pitfalls a company considering a share buyback deal should be aware of to ensure a successful and compliant share buyback transaction.

A share buyback is the purchase by a company of its shares from one of its shareholders. This article considers the company law requirements relating to a share buyback for a private limited company and common mistakes which can be made.

For further information on why a share buyback may be carried out and why it is important to structure the transaction correctly and in accordance with company law, please refer to an earlier article; “Share Buybacks and the Importance of Structuring Your Transaction Correctly”.

Constitution

The Company must not be prohibited from carrying out a buyback under its constitution. The Company’s articles of association, together with any shareholders agreement between the Company’s members, should be reviewed to make sure there is nothing which prohibits the buyback or requires the shares in question to be offered to an existing shareholder first.

Paperwork

A formal procedure must be followed and certain documents must be used.

The contract for the sale and purchase of the shares is called an off-market purchase agreement and is made between the seller and the Company. This has to be approved in advance by such eligible shareholders of the Company who hold more than 50% of the voting rights (unless, the Company’s constitution requires a higher percentage to approve the contract).

The member whose shares are being purchased will not be eligible to vote. This consent is required to be formally obtained, which may potentially require the agreement to be made available for inspection for a number of days.

It is understood that Form SH03 should be used as the instrument to transfer the shares rather than a Stock Transfer Form. This is the instrument which will be stamped by the Stamps Office if the Stamp Duty is due on the transfer. This subsequently will be filed at Companies House.

If the shares in question are to be immediately cancelled following the transfer, which increases the remaining shareholders proportionate shareholding, then Form SH06 will also need to be completed and filed at Companies House.

Funding and timing

Generally, the Company must pay for the shares in cash on completion using its distributable reserves. While a post-completion loan back to the Company from the seller is not prohibited (provided the cash flows between the parties) it may cause the seller to lose capital gains tax treatment.

If the Company cannot pay in full on completion then there are alternative options which can be considered. For example, the Company could purchase the shares in instalments through a series of fixed future sales of the shares.

However, this needs to be balanced against:

• the seller retaining a shareholding and therefore an element of control;
• the seller not being able to claim Entrepreneurs’ Relief if they do not want to be involved in the business in the interim period; and
• the Company needing sufficient distributable reserves to afford the transaction at the point of each sale.

The Company may be able to fund a buyback transaction through its capital, but unless the consideration is sufficiently small, the directors will have to follow a strictly prescribed procedure involving a declaration of the Company’s solvency and an auditor’s report. Failure to do so will mean that the Company has committed an unlawful distribution of capital.

This can have a number of consequences, including breach of director’s duties. Directors in breach of their duties or sellers with knowledge of the illegality may be personally liable to repay an unlawful distribution.

An alternative option to a share buyback is a share-for-share exchange and the introduction of a ‘holding company’ above the Company. This is where the ‘continuing’ shareholders transfer their shares to the holding company in consideration for the issue of shares in the holding company. At the same time, the seller will transfer his shares for a consideration which can be paid over time. HMRC clearance should be obtained for the share-for-share exchange and notably the holding company will be required to pay stamp duty (if any due) on all the shares it acquires.

Surrenders and gifts of shares

Events which differ to the buyback of shares include surrenders and gifts. Although an ‘exiting’ shareholder may mistakenly think that they have the same effect, they should be treated with caution.

A surrender of shares (i.e. a shareholder simply giving up his rights to the shares) will usually be void unless the shares are forfeited pursuant to a process for a shareholder’s failure to pay amounts due on the shares.

A buyback cannot be for nil consideration under company law. Rather shares can be gifted back to the Company using a Stock Transfer Form. However, the Company will then be the owner of such shares. It is understood that the Company will have to be recorded on its own Register of Members and will have to either follow a reduction of capital or transfer procedure to part company with the shares.

Share buyback advice from specialist solicitors

Early advice is essential. Our specialist corporate and commercial solicitors can work with you from the outset to consider your Company’s constitution and how to fund and structure your transaction effectively.

They can also look to incorporate provisions to structure leaver events (shareholders ceasing to undertake work for the Company) by way of a share buyback in succession planning documents.

If you are contemplating selling your shares, buying out a shareholder, or are even worried about the status of a past buyback, then please contact BHW’s corporate team on 0116 289 7000 or email info@bhwsolicitors.com.