Unit 3

Buy Back of Shares

Part A

Q1) What is buyback of shares? Why buyback of shares is done? (5 marks)

A1) Buyback of shares is a corporate action event wherein a company purchases its own stock from the existing shareholders at a price higher than the current market price. The buyback of shares in India is generally done either through a tender offer or an open market offer through the Stock Exchange.

The buyback of shares also known as Shares repurchase, allows a company to strengthen the promoter holding, utilize the free cash reserves optimally by rewarding the shareholders, and achieve the optimum capital structure.

The buyback of shares is beneficial to a company as well as the shareholders. A company announces a buyback on account of various reasons stated below:

1. The buyback helps a company to boost the share prices of their undervalued stock.
2. The surplus cash returned to shareholders via buyback helps boost the shareholder's value and confidence.
3. The buyback acts as a finance reengineering tool to achieve the optimum capital structure.
4. The buyback helps increase the promoter's stake and thus acts as a defense strategy to protect them from the threat of hostile takeovers.
5. The buyback allows shareholders to exit at a premium price as buybacks are offered at a price higher than the current market price.

Q2) Why would a company buyback its own stock? (5 marks)

A2) The buyback of shares allows a company to invest in itself and offers various benefits for such investment. A company opts for a buyback to avail the below advantages of purchasing its own stock.

1. Buybacks boost the share prices rectifying the prices of undervalued stocks.
2. Buybacks improve the company's Key Financial Ratios like Earning Per Share, Return on Equity, Return on Asset.
3. Buyback works as an alternative mode of reduction in capital without requiring approval from National Company Law Tribunal or Court.
4. Buyback serves as a financial engineering tool to optimize the capital structure of the company.
5. Buyback is a defense strategy to prevent hostile takeovers.
6. Buyback provides an easy exit route for shareholders for undervalued stocks.
7. Buyback helps optimum utilization of free cash with not many options of investment.
8. Buyback serves as a health check on the company's financial position as only the companies with good liquidity position are allowed to announce buyback offers.

Q3) Who can participate in the buyback of shares? (5 marks)

A3) Buyback of shares in India is a relatively new concept and has started gaining momentum recently. The buyback of shares is governed by SEBI (Buyback of Securities) Regulations 1998 that lays down the guidelines for the buyback process. The 1998 regulations have recently got replaced with SEBI (Buyback of Securities) Regulations, 2018. In this article, let us discuss the meaning of buyback of shares, reasons, methods, benefits, and much more.

Buyback of shares meaning

A buyback of shares is buying back of own shares by a company that was issued earlier. It is a corporate action event wherein a company makes a public announcement for the buyback offer to acquire the shares from existing shareholders within a given timeframe. The buyback of shares is also known as a stock buyback or repurchase of shares. The company announces an offer price for the buyback that is generally higher than the current market price.

Two factors decide the eligibility of a person to participate in the buyback of shares:

1. Whether the person is an existing shareholder; and
2. Whether the shares are in Physical or Demat form.

To be eligible to participate in the Tender offer buyback, a person needs to be an existing shareholder as on the Record Date of the buyback offer. In case of an open offer, any shareholder holding the shares of that company during the buyback period can participate in the buyback offer.

In the Tender offer, the shares can either be in physical form or Demat form. While in the case of an open offer, generally only the Demat shareholders can be a part of the buyback offer.

Note: The buyback of physical shares in an Open offer requires the company to maintain a separate window for the buyback of physical shares and follow a set of guidelines, as stipulated by the exchange for the physical stock. Thus, to avoid this, not many companies allow the physical shareholders to participate in the open offer buyback unless their shares get dematerialized.

Q4) What are the methods of buyback of shares? (5 marks) (2017)

A4) SEBI Buyback Regulations prescribe three methods of buyback of shares in India. A company can buy back the securities through any one of the following modes:

Buyback of shares through tender offer

In a tender offer, the company buys back its shares from the existing shareholders at a fixed price on a proportionate basis within a given time frame. The company issues a letter of offer and Tender Form to all the eligible shareholders on the company records as on the buyback record date. All the eligible shareholders who hold the shares either in physical form or Demat can participate in the buyback offer.

Buyback of shares through open market

In the case of buyback of shares from open market, a company can do so either through the stock exchange or the book-building process.

In the case of buyback from the open market through the Stock Exchange mechanism, a company can buy back the shares only on the stock exchanges having nationwide trading terminals via an order matching mechanism. The promoters are not allowed to participate in the open market offers through the stock exchange. All other shareholders holding Equity shares of the company can participate in this offer.

In the buyback through the book-building process, the buyback gets routed through electronically linked bidding centers. The company appoints a merchant banker to handle the buyback procedure. The merchant banker and the company determine the buyback price based on the response received for the buyback.

Buyback of shares from Odd-lot holders

In the case of buyback from the odd-lot holders, the company buys directly from the odd-lot shareholders by approaching them. An odd lot holder is a shareholder with shares lesser than the marketable lots as specified by the stock exchange. This method of the buyback is less common in India.

Q5) How is buyback of shares done? (5 marks)

A5) Buyback of shares is done out of the free reserves of the company. As a first step, the company desiring to go for buyback needs to approve the buyback proposal in the board meeting and decide on the mode of the buyback.

Post the buyback proposal is approved, the below sequence is followed to complete the buyback.

1. The company makes the public announcement mentioning the mode of buyback.
2. The company issues a letter of offer and Tender form. (applicable in case of a tender offer)
3. Interested shareholders approach their stockbrokers to tender their shares for buyback or put their bid for buyback in case of an open market offer.
4. The stockbrokers then submit the tender forms and other applicable documents to the company registrar and also places a bid in case of a tender offer.
5. In case of an open offer, the stock broker places a sell order against the buy order placed by the company for the buyback.
6. The registrar verifies the tender forms and informs the exchanges on acceptance/non-acceptance of the tendered Equity shares.
7. The acceptance of the shares in an open market offer happens based on order matching and gets executed on relevant pay-out dates.
8. The shareholder receives due consideration in return for the accepted shares.
9. As the last step, the company destroys the shares purchased by them within a stipulated timeframe.

Q6) How buyback of shares can be made? (5 marks)

A6) The buyback of shares can be made through your stockbroker.

The interested shareholders that are eligible to participate in the buyback offer need to approach their respective stockbrokers indicating the details of the shares that they want to offer in the buyback. The stockbroker, in turn, places an order on your behalf on the exchange platform. You get cash in return for the successfully accepted shares.

Points to note:

1. The physical shareholders need to submit the physical share certificates along with required documents to the stock broker.
2. The acceptance of shares in the case of an Open offer is based on the order matching mechanism.
3. The acceptance/non-acceptance of shares in the case of a Tender offer is decided by the Registrar based on the details provided in the Tender form.

Q7) How are buy back stock issued? (7 marks)

A7) Recently, we have seen a spur in the buyback offers by the company. Do you know why do the companies buy back stock that was once issued by them? There are several reasons associated with it that urge a company to announce a buyback.

Undervalued stock

This is one of the main reasons why companies opt to buy back their shares. When the management feels that their stock is undervalued, they adopt the buyback route to rectify the stock price. The stock buyback reduces the number of shares in the market and thus gives a price boost to the remaining shares in the market.

Excess Cash with not many projects’ opportunities

A company with free reserves in hand but not many project opportunities would prefer to go for a buyback. The company would use the cash to reward the shareholders rather than keeping it idle in the bank account over the required amount.

Tax-efficient method of rewarding shareholders

The dividends get taxed at two levels. First, at the company level and a second time in the hands of the shareholders. However, in the case of a buyback, only the company is liable to pay a buyback tax. The capital gains tax on the income from the buyback of shares is exempted for the investor. Thus, buybacks prove to be a more tax-effective way of distributing rewards to the shareholder.

Strengthen promoter holding in the company

The company promoters can increase its stake in the company by forfeiting the buyback offer. This strengthens their hold over the company and acts as a defense strategy in the case of hostile takeovers.

To achieve optimum capital structure

The capital structure of a company gets represented by its debt-equity ratio. Each industry has a different capital structure requirement. Some industries may not be suitable to rely on more debts, whereas some other business models may require large debts to run their business. Thus, as per the company requirement, a company may opt for buyback as a tool and repurchase its equity from the market to achieve an optimum capital structure.

In India, the buyback is done only through the extinguishing of shares. However, in other countries, buyback is also done to reward employees. The company buys back the shares from the public and distributes them to employees as ESOP. It helps avoid dilution of existing shareholding and compensates employees without any fresh issue of share.

Q8) Explain the procedure of Buy back of shares? (7 marks)

A8) A buyback of shares is a corporate action event in which a company purchases its shares from the existing shareholders either via a tender offer or from the open market. A buyback of shares can be out of company free reserves or the securities premium account. Below is the generic buyback process.

1. As a first step, a company approves the buyback proposal in a board meeting.
2. Post that, the company makes a public announcement for the buyback. The buyback announcement mentions the mode of the buyback.
3. The company then files a letter of offer with SEBI in case of a tender offer.
4. Interested shareholders approach their stockbrokers to tender their shares for buyback or put their bid for buyback in case of an open market offer.
5. The stockbrokers then submit the tender forms and other specific documents like physical share certificates to the company registrar in case of a tender offer.
6. The registrar verifies the tender forms and informs the exchanges on acceptance/non-acceptance of the tendered Equity shares.

(i) The non-accepted shares get returned to the shareholders.

(ii) The acceptance of the shares in an open market offer happens on order matching and gets executed on relevant pay-out dates.

7.   Once the shares get accepted, the shareholder receives the cash in return for the shares offered in the buyback.

8.   Lastly, the securities purchased in buyback are destroyed/extinguished by the company.

Q9) State the impact of buy back of shares. (5 marks) (2018)

A9) In India, share buybacks are only made by the extinction of shares. However, in other countries, share buybacks are also being made to reward employees. The company buys back shares from the general public and distributes them as ESOPs to employees. This helps avoid diluting existing shareholdings and compensates employees without issuing new shares.

Share buybacks are a great tool for financial reengineering. A share buyback is the repurchase of a company's previously issued shares from the market. Buying back shares is the opposite of issuing shares by a company. It means that the company buys its own stock or certain other securities. In the case of a share buyback, the company offers to buy back the shares owned by the investor at a specific price that is generally determined or reached based on the average stock price over the past few months. This calculation is usually done with a premium market price to attract more investors, but this may depend on the financial prudence of the company. As such, share buybacks are one of the major modes of recapitalization.

Ashare buyback has various impacts on a company's financial and other aspects.

1. Increase in Earning Per Share

With the buyback of shares, the total number of outstanding shares in the market reduces. With earnings remaining the same and the number of Equity Shares reducing, the Earning Per Share (EPS) ratio shows a significant improvement.

2.   Boost in Share Price

The buyback generally has a positive impact on share prices. The buyback of shares will increase stock price. The buyback would shrink the supply of shares in the market on one side. On the other hand, with an increase in the EPS, people would prefer to buy the stock leading to a sudden demand for such securities. With higher demand and lesser supply, the prices of the shares get boosted.

3.   Improvement of Financial Statements

The buyback of stock will also have a positive impact on the financial statements reflecting an improved return on asset (RoA) and return on Equity (RoE) with a reduction in assets by way of reduced cash holding used to buy back the stock and a reduction in the number of Equity shares with the repurchase of shares.

4.   Increase in Shareholder Value

With the reduction in the number of equity shares in the market, the percentage of ownership held by each shareholder increases leading to an increase in the shareholder value.

Q10) Difference between Tender Offer and Open Market Offer Through Stock Exchange. (5 marks)

A10) Buyback through Tender Offer Route Vs Buyback through Open Market Offer route

Part B

Q1) (Various Alternative / option for buy-back)

The undernoted balances were extracted from Balance Sheet of Zee Ltd.

The directors of Zee Ltd. Have decided to buy back Equity Shares. Conditions as per the Companies Act have been complied with. Ascertain the possible buy back of shares of Equity Shares.

(a)    Buy back maximum Equity Shares atpar.

(b)    Buy back 4000 Equity Shares at best possibleprice.

(c)    Buy back maximum Equity Shares at Rs.40/- pershare.

(d)    Buy back maximum Equity Shares @ 10%Discount.

(e)    Maximum no. Of Equity Share at Best possibleprice. ( 8marks)

A1)

Calculation of maximum no of Equity shares & maximum Offer Price

1. Therefore company can buy back maximum 5,000 Equity Shares at par.
2. Maximum Amount of Buy back as per the table above: Rs 1,12,500

No of Equity shares Buyback: 4,000 shares

Therefore, Buy Back Price = 1,12,500/4,000 = Rs 28.125 (18.125 premium)

c.  Maximum Equity shares bought back= 1,12,500/40 = 2,812 shares

d.  Offer Price is Rs 9 per share (at 10% discount)

No of shares that can be bought back= 1,12,500/9 = 12,500 shares

But the company cannot buy back more than 5,000 shares (as per the table)

Hence, the company can buy back 5,000 Equity Shares at Rs.9/- per share as per limits.

e.  Maximum amount of Buy back (as per the table) = Rs 1,12,500

Maximum number of shares (as per the table) = 5,000 shares

Maximum offer Price (as per the table) = Rs 22.50

Note: In any of the cases, the buyback amount should not exceed the limits as per the table.

Q2) (Various Alternative / option for buy-back) 

Balance Sheet of Neena Ltd. As on …………

Ascertain the number of equity shares that can be bought back if –

(A)  The buyback of maximum no. Of shares at par.

(B)  The buyback of maximum no. Of shares at premium of Rs.25/-.

(C) The buyback of 800 Equity shares at Best possible price.

(D) The buyback of maximum no. Of Equity shares at Best Possible Price.

Consider above option separately individually. (8 marks)

A2)

Calculation of maximum no of Equity shares & maximum Offer Price

1. Maximum No of shares (as per the table)= 1,000 shares

Offer Price (at PAR) = Rs 50 per share

Amount of Buy back= 1000 x 50 = Rs 50,000

B.   Offer Price (Premium Rs 25) = 50 + 25 = Rs 75 per share

Maximum No of shares (as per the table) = 1,000 shares

Amount of Buy Back= 1000 x 75 = Rs 75,000

C. No of Shares (given)= 800 shares

Maximum amount of Buy Back (as per the table) = Rs 1,97,500

Offer Price = 1,97,500/800 = Rs 246.88

D. Maximum No of shares (as per the table) = 1,000 shares

Maximum amount of Buy Back (as per the table) = Rs 1,97,500

Offer Price = Rs 197.50

Q3) (Buy back at par, fully out of fresh issue of Preference shares)

Bharat Ltd. Decides to buy back 50,000 Equity Shares of Rs.10/- each; for this purpose the company issues 10% Preference Shares of RS.100/- each of the equivalent amount. Assume that the buy back is carried out actually on the legally permissible terms, each Journal entries. (5 marks)

A3) Journal in the books of Bharat Ltd.

Note: CRR is not to be created as buy back is out of proceeds of fresh issue of Preference Shares.

Q4)(Buy back at premium, out of Divisible profits.)

Z Ltd. Decided to buy back 20,000 Equity Shares of Rs.10/-each @ Rs.5/- premium per share. Assume that there is sufficient balance in Securities Premium and Profit and Loss account. Pass journal entries. (7 marks)

A4)

Journal entries in the books of Z Ltd.

Q5) (Buy back at Discount and Issue of 12% Preference shares)

K.T. Ltd. Bought back 6,000 Equity shares of Rs.20/- each at Rs.19/- per share. The company had issued 10,000 12% Preference Shares of Rs.10/- each at par, for the purpose of buy back.

Pass Journal entries. (5 marks)

A5)

Journal entries in the books of KT Ltd.

Q6) (Buy back of shares out of divisible profits.)

A company buy back 25,000 Equity shares of Rs.10/- each at Rs.40/- per share. The reserves of the company are as follows:

Security Premium Rs.20,00,000/-

General Reserve Rs.30,00,000/-

Profit & Loss A/c Rs.2,00,000/-

The company sold investment for Rs.16,50,000/- at 10% profit. Pass the necessary entries in the books of the company for the above. (5 marks)

A6)

Journal entries in the books of the company

Q7) (Maximum buy back of given price)

The Balance Sheet of Ketan Ltd. As on 31st March 2009 is as follows.

Keeping in view all the legal requirements, ascertain the maximum no. Of Equity shares that Ketan Ltd. Can buy back @ Rs.50/- per shares. Assume that the buy back is actually carried out. Investment costing Rs.3,00,000/- sold for Rs.3,20,000/-

Pass Journal entries and prepare Balance sheet after buy back. (7 marks)

A7)  Calculation of maximum no of Equity shares & maximum Offer Price

Journal entries in the books of Ketan Ltd

Balance Sheet of Ketan Ltd (after Buyback)

Notes to Accounts forming a part of Balance Sheet

Q8) (Maximum buy back at best possible price)

Balance sheet of YES Ltd. As on 31st March 09

Other Information:

1. Fixed Asset costing Rs.20,00,000/- W.D.V. Rs.18,20,000/- sold for Rs.19,00,000/-
2. Investment costing Rs.10,00,000/- sold for Rs.12,50,000/-.
3. 10% Preference shares of Rs.5/- each issued at par, for purposed of buy back of security shares.
4. The company wish to buy back the maximum number of equity shares at maximum price as may be possible. Legal requirements have been complied by the company.

You are required to determine the –

i)    Maximum shares can be brought back at best possible price.

Ii)  Pass journal entries for above transaction (Narration not required)

Iii)  Balance sheet after buy back. (8 marks)

A8)

Calculation of maximum no of Equity shares & maximum Offer Price

Journal entries in the books of YES Ltd

Bank A/c

Balance Sheet of Ketan Ltd (after Buyback)

Notes to Accounts forming a part of Balance Sheet