In today’s time, shares buyback is gaining popularity especially after the major IT companies like TCS, Wipro, and Infosys announces share buyback. Share Buyback is simply means repurchasing company’s own shares from investors. But the question here is why do companies tend to repurchase its own shares, how does buyback works, are there any eligibility criteria to apply for buyback, and how to apply for shares buyback.
Let’s talk about everything in detail in this article.
What is Shares Buyback: Meaning?
When a company decides to repurchase its outstanding shares from the market it is called stock buyback or shares buyback. As shares are repurchased by companies which reduces the number of outstanding shares available in the hand of investors.
An issuer company generally purchases back its shares from existing shareholders at a premium over the share’s current market price. As the buyback price is set at a higher price than the market price which encourages investors to apply for the buyback process.
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Important Conditions for Shares Buyback
- A company can repurchase maximum 25% of its paid-up equity share capital through announcing share buyback.
- 15% of buyback offer is reserved for retail investors holding investment worth less than Rs 2 lakh in their Demat account.
- Rest 85% of the buyback offer or issue size is reserved for non-retail category of investors including FIIs, DIIs, Mutual funds, and promoters.
- Post buyback offer, the maximum permissible debt to equity ratio should be within 2:1.
- A company can announce buyback of upto 10% of total paid-up equity capital + reserves by passing board resolution.
- If the size of buyback is upto 25% of total equity paid-up capital + reserves, special resolution is required to make the buyback offer.
- A company can utilize its free reserves, securities premium account, or proceeds from issue of other specified securities to buy back shares from investors.
Methods of Shares Buyback
There are two methods of buyback that a company can choose to acquire shares from existing shareholders – Tender offer and Open market offer.
Let’s understand each of the buyback methods;
1. Shares buyback through tender offer
When a company is willing to announce buyback of shares from existing investors at a certain fixed offer price is called tender offer buyback. Company who makes buyback offer issues a tender form to all eligible investors on the buyback record date. All the buyback details including buyback price, duration, and number of buyback shares company purposes to repurchase are clearly mentioned in the tender offer.
All eligible shareholders as on the buyback record date can participate in the tender offer buyback to tender or sell their shares at the buyback price. The offer price in tender route is set at a premium to the current market price to compensate investors for selling them rather than holding them.
Tender offer buyback remains open for few days. If the number of shares tendered exceeds the number sought, then the company purchases less than all shares tendered at the purchase price on a pro rata (proportionate) basis to all who tendered at the purchase price. This is called as proportionate buyback.
2. Shares buyback through open market offer
In this type of shares buyback, a company purchase shares directly from the open market. There are two mechanisms of open market buyback – stock exchange and book-building.
In the stock exchange mechanism, company purchases shares directly from sellers on the exchange. Existing shareholders can simply place a sell order on exchange and if your order gets matched, shares will be buyback by the company. Any shareholder can participate in the open market buyback through stock exchange. Only promoters cannot participate in such buyback offer.
Second is the buyback through book-building process, wherein the buyback issuer company appoints a merchant banker to set buyback offer price based on the bid received from shareholders on the electronic bidding centers.
Open market buyback can lasts for few months and there is no concept of record date or proportionate basis allotment. The company only announces the maximum buyback offer price and it has flexibility to repurchase shares at any price upto the maximum price.
Why do companies’ buyback its own shares?
After knowing what buyback is, you must be willing to know that why do companies repurchase their own shares from market.
- To balance firm’s capital structure through creating a optimal use of equity and debt capital source.
- As shares are acquired back by the issuing company which reduces the outstanding shares held by public and thereby increases the earning per shares (EPS) even at same profit levels.
- Buyback helps to take the advantage of undervaluation. The company repurchases the currently undervalued shares, wait for the market to correct the undervaluation whereby prices increase in the intrinsic value of the equity, and re-issue them at a profit. Share Buyback helps reducing the cost of capital. Buying back some or all of the outstanding shares can be a simple way to pay off investors and reduce the overall cost of capital instead of paying the dividends which is a cost of equity.
- Companies also more readily repurchase shares at a profit when the stock is liquidly traded and the companies’ activity is less likely to move the share
- Buyback of shares also allow companies to distribute their earnings to investors without inflicting them with taxation.
- Share repurchases avoid the accumulation of excessive amounts of cash in the corporation.
- It supports the share price during periods of sluggish market conditions.
Eligibility criteria to apply for buyback
Undoubtedly, there are certain eligibility criteria predefined by SEBI to apply for shares buyback. If you want to apply for buyback of shares, you must check whether you meet the following conditions or not to be an eligible shareholders.
- You must be an existing shareholder by having company’s shares in your demat account.
- You must own company’s shares as on or before the record date declared for buyback. For instance, if the issuer entity has set record date to 10 July, means your demat account must have holdings by 10 July. If you have purchased shares on 10 July then it will take T+2 working days to credit the shares into your Demat account thus, you will not be an eligible shareholder and cannot participate in the buyback offer.
- Although it is not necessary but it’s good to have share holdings in the buyback entitlement ratio. For instance, if company announces buyback ratio of 15:3 and if you have 15 shares in your demat account means the company can buy back 3 shares.
How to apply for Share buyback?
If you are an eligible shareholder, you can apply for buyback of shares online through your stockbroker. You can directly tender your demat account holdings for buyback through broker’s trading platform. One can apply for the buyback during the buyback period only.
Check out the steps on how to participate in the buyback offer;
- Log into your trading account with your broker
- Search for the corporate action or buyback event option.
- Click on the company’s name of which shares you want to tender or sell.
- Fill in required details like the number of shares you want to sell in the tender offer and submit the order.
- That’s done! Your buyback order is successfully submitted.
Note: Once shares are tendered then company decides an acceptance ratio which is the likelihood of how much of applied or tendered shares will be accepted for buyback. Any number of shares over and above the acceptance ratio, will be credited back to the applicant’s demat account.
If in case retail category for buyback receives less subscription than 15% means company may have 100% acceptance ratio and all the tendered shares by retail investors will be approved for buy back.
Benefits of Buyback of shares for company and investors
- Investors can tender or sell their shares to company at a higher price to get profits.
- Long-term capital gain on buyback of shares is tax-free.
- Buyback increases share price.
- Buyback of shares reduces outstanding shares and boosts Return on equity and EPS.
- It helps to design an effective or optimal capital structure.
- Shares buyback provides easy exit route to existing shareholders.
Final thoughts on Shares buyback
Whether buyback of shares by a company is good or bad depends on multiple facets. Like if a company has solid growth prospectus and investors have risk appetite too then shareholders may stay invested in the company to get more profits by holding it. Unlikely, if you have low risk appetite and just want to make some returns by selling shares, you may consider tendering of shares for the buyback to get 10%-15% of premium over the prevailing market price.
The choice is ultimately yours whether to stay invested in the company or offloads the holdings over some premium.
