Share Buy-back – The Hidden Way to Boost Shareholders’ Value
What is share Buy-back?
Share buy-back means purchasing back the shares issued by the Company to the shareholders/members. Intentions for initiating this transaction can be to consolidate the ownership, increase the promoters’ shareholding, to adjust the undervalued shares etc.
How does it work?
Essentially, whenever the Company has huge surplus in the form of reserves and no immediate or major investment to be made in the near future, the need for returning the unutilized surplus to the shareholders might arise. Either a Company may pay dividend to the shareholder, or it may go for buy-back of shares.
Under the provisions of Indian corporate law i.e. the Companies Act, 2013, the Articles of Association (charter document) shall have the enabling clause for allowing the Company to buy-back its own shares. If not, the Company shall initiate the process to alter its documents and insert the required clauses. Once this process is completed, the Company has to take approvals from the Board of Directors or shareholders based on the percentage of shares to be repurchased. Upon procurement of necessary approvals, the Company then shall make an offer to the shareholders to buy-back the shares via letter of offer and the shareholders may offer their shares for buy-back.
Consideration for the buy-back can be from the free reserves, securities premium account or the proceeds of the issue of any share or other specified securities.
Boosting value of shares:
One of the primary motives to do Buy-Back of shares is to increase the value of shareholders. By reducing the number of shares in the total share capital of the Company, the earnings per share (EPS) will be increased. It will also help the Company to improve the return on investment (RoI) to the shareholders enhancing the return on net worth and long-term shareholder value.
Companies also tend to use the share buy-back scheme as a weapon to combat during recession or while correcting the market value of their shares. By this scheme, the debt-equity ratios of the Company can be improved.
Value for shareholders:
Apart from the increased Earning per share and return on capital, the major advantage of share repurchase scheme is the tax benefits available to the shareholders. Whenever the Company has surplus cash, it tends to return the same either by declaration of dividend or share repurchase. Though the dividend declaration process is easy and convenient, the incidence of tax in the hands of the shareholders is heavy as it is taxed at income tax slab rates applicable to the respective shareholder. Whereas in Share Repurchase scheme, the incident of tax is on the Company under Section 115QA of the Income Tax Act, 1961, and as a result, the shareholders are not burdened by paying tax on profit made on the shares offered by the Company under buy-back scheme.
A Company buy-back its shares when it wants to consolidate ownership, return stock prices to real value, boost financial ratios, or reduce the cost of capital. Investors can benefit from stock buy-back because the practice has generally taken the place of dividends because if shifting of tax incidence from Company to the Shareholders.
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