Buyback of shares – Meaning, Reasons, Methods and Procedure of Buyback of Shares

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BuyBack-Share

People showing increasing interest in the share market would surely come across the term “Buyback of shares” at least a few times in their research. While those involved in trading, company management, share market, and share or accounting related fields would have most likely heard of this concept at some point, it may be a new term for those who are not in these fields. 

Explaining what the buyback of shares is?

A company can repurchase its own shares from an individual or a group of investors under the term buy back of shares. The buy-back is duly completed at a slightly higher price than the market value. The buyback of shares may be initiated by a company for various reasons, including the following.

What are the reasons for buyback of shares in India?

  1. Ownership Consolidation

Being a shareholder of a company effectively means that the shareholder is a partial owner. As well as a vote in the company’s decision-making process. When you issue too many shares without using the capital gained against them, you just dilution your own hold on the company without any benefit. Thus, most companies refrain from issuing a lot of shares without reason or buy back their shares if there is no potential use for their cash in hand to keep a firm hold on their company.

2. Presence of unusable cash

Unusable cash is extremely expensive for every company out there. It is said that understanding the difference between reserves and excess cash is one of the most important lessons for business owners. By issuing shares, a company raises capital and subsequently dilutes its owners’ stake. 

However, that is not the only drawback. A shareholder expects dividends from a company-therefore, the company is paying for the funds it raised. If these funds are not being used, the company is practically wasting its capital. The buyback of stocks in such cases may be a smart move for the company. This would reduce the overall cost of capital as well as pay off the investors.

3. Undervalued Stock

When a company believes its shares are undervalued, it may initiate a buy-back. There are several reasons why shares can be undervalued, such as a poor short-term performance or some sensational news. If a company believes that its share price will recover in the future, it may repurchase its shares at the undervalued price. As soon as the stock recovers, reissue them to increase equity capital without issuing any additional stock. 

4. Demonstrate financial soundness

One of the interpretations of stock buyback can be the financial soundness of a company. That the company no longer needs funding and the management has confidence in the stability of the company even after buyback of shares. Investors typically view a buyback as a positive sign. Thus, it may even lead to a rush of investors buying the stock.

5. Fix for financial statement

Buyback of shares leads to an increase in the earnings per share ratio of a company as the dividend is divided among fewer shareholders. This makes the financial statement more attractive for investors. Furthermore, a company with a scheduled buyback draws the attention of short-term investors too. An influx of investors inflates a stock value artificially and even boosts a company’s price to earnings ratio.

What are the methods for buyback of shares?

Buyback of shares in India is done following SEBI Buyback Regulations. Buyback of shares by the company can be done through following modes:

  1. Through the tender offer

A company sets a fixed price on a proportional basis within a given timeframe to buy back its shares from its existing shareholders. According to the company’s records, a letter of offer and tender form are sent to eligible shareholders. The eligible shareholders may participate in the buyback offer.

  1. Through open market

In this, a company can either choose to buy back through the stock exchange or the book-building process. In the case of buyback through the Stock Exchange, the buyback can be done only on the stock exchanges with nationwide trading terminals via an order matching mechanism. Except for promoters, shareholders holding Equity shares of the company may participate in this offer.

In the case of buyback through the book-building process, a merchant banker is appointed by the company to handle the buyback procedure. Based on the response received from the merchant banker and the company, the buyback price is determined.

  1. From odd-lot holders

In this case, the company directly approaches odd-lot shareholders to purchase shares. An odd lot holder owns fewer shares than the stock exchange specifies as marketable lots. In India, this is a less common way to buy back shares.

Let’s know about buyback of shares procedure

  1. Firstly, approval for the buyback is needed in a board meeting of a company.
  2. After that, a public announcement for the buyback along with the decided mode is made.
  3. In case of a tender offer, a letter of offer with SEBI is filed.
  4. In case of the tender offer, interested shareholders approach their stockbrokers (ii) In case of an open market offer, interested stockholders put their bid for buyback
  5. In case of the tender offer, the stockbrokers submit the tender forms and other required documents to the company registrar.
  6. Then, the tender forms are verified by the registrar. Acceptance or non-acceptance of the tendered Equity shares are then notified by the registrar. (i) The non-accepted shares are returned to the shareholders. (ii) For accepted shares, the shareholder receives the cash for the shares.
  7. In an open market offer, shares are accepted on order matching and the order gets executed on relevant pay-out dates.

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Conclusion

When discussing the buyback of shares, we learned why the companies are doing it. We can see the major benefits of utilizing this activity here. Also, we discussed how to buy back shares that benefit or influence retail investors. Keep an eye on chart analysis for more updates and important information about the stock market.

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