Like other forms of property, a person can typically buy and sell shares. However, the Corporations Act 2001 (Cth) (the Act) imposes strict requirements when a company wishes to purchase its own shares from members. This process is known as a share buy back. Below, we explain what it is, why they happen and the various types of share buy backs.
What is a Share Buy Back?
A share buy back occurs when a company makes an offer to purchase its shares from shareholders. In general, a company is not permitted to buy its own shares (capital maintenance rule). This rule states that companies must maintain their share capital as a fund for creditors.
Nevertheless, the Act does permit share buy backs subject to certain requirements and procedures. A company can acquire its shares if the buy back does not materially prejudice its ability to pay its creditors and it follows all procedures prescribed in Part 2J.1 Division 2 of the Act. When a company makes an offer to purchase shares, and a member accepts it, the rights attaching to those shares are suspended until the parties terminate the agreement. The company must then notify the Australian Securities and Investment Commission (ASIC) that they have cancelled the shares.
Why Do They Happen?
There are several commercial reasons why companies choose to buy back their shares, including:
- Increase the earnings per share;
- Reduce the threat of a takeover (the company reduces the number of shares available to a hostile bidder);
- Return excess funds, due to lack of appropriate investment opportunities, to members who can use them more efficiently than the company;
- Signal to the market undervaluation of the company;
- Reduce administrative overheads (the company purchases shares from members with parcels of odd-lot shares); and
- Facilitate the sale of employee shares (company purchases the shares of employees leaving the company).
Types of Share Buy Backs
The Corporations Act permits five types of a share buy back.
1. Minimum holding share buy back
A minimum holding buy back occurs when a company acquires all of a holder’s shares in a company if the shares are less than a marketable parcel (i.e shares generally valued less than $500 or shares difficult to sell). It is also known as an odd-lot buy-back. A company will typically engage in this kind of buy back to minimise its administrative expenses and burden in meeting the needs of members with minimal shareholdings.
2. Employee share scheme buy backs
This sort of buy back occurs when a company makes an offer to purchase the shares of company employees or directors who leave the business. It can also include those of a related body corporate. The company in the general meeting must approve the buy back.
3. On-market buy backs
An on-market buy back occurs when a listed company makes an offer on a prescribed financial market in the ordinary course of trading. It can also result from an offer a company (either listed or unlisted) makes in the ordinary course of trading in an approved overseas financial market. If the company is listed, the company must offer to buy back those shares on a prescribed financial market at the same time (e.g. ASX Limited).
4. Equal access buy back scheme
To qualify as an equal access scheme, this kind of buy back must satisfy certain criteria, namely:
- Offers made under the scheme relate only to ordinary shares;
- The company must make an offer to every person who holds ordinary shares to buy back the same percentage of their ordinary shares;
- Individuals must have a reasonable opportunity to accept the offer made to them; and
- The terms of all the offers are identical.
5. Selective buy back scheme
The Act defines a selective buy back scheme negatively. It is not made under an equal access scheme and is not a minimum holding buy-back. It is also neither an on-market or employee share scheme buy back.
This type of buy back occurs when a company chooses to acquire shares from particular members other than ordinary shares (e.g. preference shares). As these buy backs are unequal, they are subject to stricter regulation. Ordinary shareholders must unanimously approve (known as a special resolution) the buy back in a general meeting. Approval must occur during a general meeting to alert other members whose shares may be at risk.
A company must notify ASIC in advance if it intends to enter into a buy back scheme. Typically, a company cannot purchase more than 10% of its shares within a twelve month period (the 10/12 limit).
If your company is considering a share buy back and you have any questions, get in touch with our commercial lawyers on 1300 544 755.