An Introduction to Share Buybacks for Family Investment Companies

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When a shareholder wants to extract their capital from a Family Investment Company (FIC), the normal approach is for the company to buy back the shareholder’s shares. This is known as ‘share buyback’ and can also be used for other types of privately held companies where there is no willing outside buyer or the other existing shareholders do not wish to bring in a new shareholder.

There are strict rules around how share buybacks must be carried out, including compliance requirements under the Companies Act 2006. There are also tax considerations and the matter of any restrictions imposed under the company’s articles of association and shareholders’ agreement to work through.

In this article, we cover how share buybacks work, the legal requirements (including those under the Companies Act 2006), tax rules for share buybacks, what happens if the proper legal requirements are not met and possible approaches to resolving a share purchase that is rendered void by a failure to follow the right legal process.

Need help with a company share buyback or any other company and commercial legal matters? Please contact Michael Budd who will be happy to advise.

Key points to know about share buybacks for FICs

  • Share buybacks involve a company buying back its own shares from a shareholder
  • A share buyback can be funded either through the company’s profits or its capital, depending on the circumstances
  • The company’s board will need to approve the purchase, either through a general or special resolution
  • The purchased shares will need to be cancelled
  • There are stricter rules for share buybacks out of capital but these may not need to be followed for low value share buybacks (i.e. the ‘de minimis’ exception)
  • The Companies Act 2006 sets strict rules for share buybacks
  • The funds received by the seller may be taxed as investment income or capital gains and the exact type and level of tax will depend on the circumstances
  • Failure to follow the correct legal process could render the transaction void, leaving the company in a difficult position
  • There are various potential options for resolving void transactions, so mistakes are not necessarily fatal (but can still be costly and time-consuming to resolve)
  • Expert legal and tax advice is strongly recommended to ensure a smooth transaction

How does a share buyback work?

A share buyback will involve a share buyback agreement between the company and the exiting shareholder. This will specify the terms of the deal, including the purchase price.

There are two types of share buyback depending on how the purchase is funded:

  1. Using post-tax distributable reserves (i.e. profits that would normally be paid out as dividends).
  2. Using the company’s capital (only available to private limited companies)

If the company does not have sufficient funds to meet the share purchase price, then one option is for the company and the seller to agree that the payment will be made in instalments.

A board meeting will be required for shareholders to approve the buyback, with proper notices for members and meeting minutes. A written resolution to approve the share buyback will need to be passed by the shareholders. A stock transfer form will need to be prepared and appropriate filings made with Companies House.

Once the purchase is carried out, the purchased shares will be cancelled by the company. All of the remaining shareholders will, therefore, retain their existing number of shares but the proportion of the company they each own will increase as there will be fewer shares overall.

The term ‘share buyback’ is also used for publicly traded companies that wish to buy back their shares from the markets, but the two processes should not be confused.

What are the legal requirements for a company share buyback?

For a purchase funded using the company’s post-tax distributable reserves, the shareholders will need to approve the purchase through a resolution. This can generally be achieved with an ordinary resolution (i.e. with a simple majority vote of shareholders) although a higher majority may be required if this is specified in the company’s articles of association.

For a purchase funded using the company’s capital, a special resolution (i.e. with 75% majority approval) will be needed. The company directors will then need to make a statement confirming that the company will be able to pay its debts and continue to operate as a going concern after the payment is made. An auditor will also need to confirm that the company is solvent in a report and a public notice will need to be published in the Gazette detailing the proposed payment. Finally, the company must file the special resolution at Companies House within 15 days of it being passed.

There is an exception to the above requirements for share buybacks out of capital. This is known as the ‘de minimis’ exception and applies to share buybacks valued at no more than £15,000 or where the proposed purchase price is less than 5% of the nominal value of the company’s share capital (whichever is the lower of these two figures will apply).

Any share buyback will also need to comply with the terms of the company’s articles of association and any shareholders’ agreement in place.

HMRC requires that the share buyback must be beneficial for the company i.e. the price paid for the shares must not be excessive.

Additionally, the share buyback will need to comply with the terms of the Companies Act 2006 (see below for more details).

What does the Companies Act 2006 say about share buybacks?

The Companies Act 2006 sets out specific requirements for company share buybacks, including:

  • The company’s articles of association must be followed, including any terms blocking share buybacks
  • The shares must be cancelled once they are purchased with the company’s issued share capital reduced by the value of those shares
  • The company must use is distributable reserves to fund the purchase in the first instance – capital can only be used if there are not sufficient reserves to cover the purchase
  • A 15-day inspection period of the proposed share purchase agreement must be allowed for shareholders ahead of a board meeting to approve the agreement
  • A formal return must be filed with Companies House within 28 days of the buyback date
  • The register of members, register of transfers and company statutory register must all be updated

Failing to follow these requirements could see the purchase considered legally void, so it is important to have good legal support during a share buyback to make sure all requirements are correctly followed.

Tax rules for share buybacks

A share buyback payment can either be treated as a ‘distribution’ (i.e. a dividend) or a disposal for Capital Gains Tax (CGT) purposes, depending on the situation. If the payment needs to be treated as a dividend, then it will be taxed as investment income, but if it is treated as a capital gain, then a lower rate of CGT will generally apply.

If the share purchase is dealt with under CGT rules, the seller will either pay a 10% or 20% rate of CGT depending on their relationship to the company.

Ultimately, which tax rules apply will depend on whether the payment falls within section 1033 of the Corporation Tax Act 2010 and the seller’s status regarding the company, so specific tax advice should be sought on this point.

What happens if the Companies Act requirements are not followed for a share buyback?

The starting position is that a share buyback would be considered void if a company fails to comply with the terms of the Companies Act 2006 during the purchase. The seller would, therefore, be in possession both of the sale price and the legal title to the shares. The danger is that they could then, effectively, hold the shares to ransom, extracting an additional payment from the company.

That said, not all failures to comply with the statutory requirements will necessarily void the transaction. For example, the 15-day inspection period can be waived by agreement of all shareholders. If a company finds itself in the position of having a potentially void share buyback, swift legal advice is strongly recommended.

How to resolve a void share buyback

There are various potential options to resolve a share buyback that is void due to non-compliance with the Companies Act. Depending on the situation, including how willing the seller is to help the company, it may be possible to:

  • Redo the purchase in a compliant manner for a nominal sum and have the remaining shareholders pass a resolution to approve the original payment as a dividend solely payable to the seller
  • Alternatively, the sale could be redone for a nominal sum and the shareholders could release the seller from any obligation to return the original payment
  • Establish that the original buyback contract was specifically enforceable
  • Attempt to unwind the transaction and have the purported purchase price returned to the company
  • Undertake a court-approved reduction of capital to cancel the shares that should have been purchased under the defective agreement

Other options may exist and exactly what might be suitable will entirely depend on the circumstances. It is therefore essential to seek expert legal advice from someone with specific expertise in these matters.

How Longmores can help with share buybacks

The team at Longmores can assist with share buybacks and any other issues related to shareholders exiting a business. We can ensure compliance with the proper statutory rules so you can be confident that a share acquisition will be considered valid.

Our Company Commercial team can also assist with any other business legal needs you have, while our Business Dispute Resolution team can step in to help with any conflicts you may be facing.

To discuss how we can help you, please contact Michael Budd who will be happy to advise.

Please note the contents of this blog are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.