Buying out a Shareholder

The most common reason that private companies buy back their shares is to buy out one of the shareholders in circumstances where:

  • The other shareholders are not able or willing to purchase his/her shares; or
  • A purchase of the relevant shares by the company is the most tax efficient method of buying out the shareholder.

A shareholder may wish to exit the Company for a number of reasons, for example, he may:

  • Have fallen out with the other shareholders;
  • Wish to retire or pursue other business interests; or
  • Want or need to raise cash.

In the event that the remaining shareholders do not purchase the exiting shareholder’s shares, the option of the company buying them is normally preferable to selling them to a third party (for companies with a small number of shareholders).

NOTE: On a buyback, the purchase price is paid directly to the exiting shareholder(s). This is in contrast to a reduction of share capital which usually results in a distributable reserve which may be available to be distributed to shareholders generally.

To return surplus cash to Shareholders
A company may have surplus cash, for example: (a) as a result of the disposal of a business or significant asset; or (b) where cash was raised to fund a project or acquisition that subsequently fell through.

It is generally inefficient for a company to hold large amounts of cash. Therefore, unless the company has a specific reason to retain this cash it may be advisable to return it to the shareholders. One way to return this cash to shareholders is to effect a buyback.

Increase gearing
It may be in a company’s interest to increase its gearing (the ratio of debt to equity) to procure an increased return for shareholders. One way to effect an increase in gearing is to lower the level of equity by effecting a buyback. A company with increased gearing may be more attractive to investors.

If a company is intending to increase its gearing it should ensure that this does not breach the terms of any financing arrangements that it has in place.

Employee share incentive schemes
A company may wish to buyback shares acquired under an employee share incentive scheme on the occurrence of a particular event or when the employee leaves the company.