In this article we will discuss about:- 1. Introduction to Buy-Back of Securities 2. Meaning of Buy-Back of Securities 3. Sources 4. Advantages.
Introduction to Buy-Back of Securities:
By virtue of section 77(1) of the Companies Act, 1956, a company limited by shares could not buy its own shares as the same would amount to illegal reduction of capital. This section specifically laid down that “no company limited by shares and no company limited by guarantee and having a share capital, shall have power to buy its own shares, unless the consequent reduction of capital is effected and sanction obtained in pursuance of Section 100 to 104 and Section 402”.
In response to the persistent demand from the corporate sector for buy-back, the Central Government promulgated the Companies (Amendment) Ordinance, 1998, permitting companies to buy-back their own shares. The Ordinance, which amended the Companies Act to become Companies (Amendment) Act, 1999, made provision for the insertion of three new sections, viz., Sections 77A, 77AA and 77B which authorise companies to buy-back their shares subject to fulfilment of the conditions laid down therein. Besides, the SEBI has also issued its own guidelines seeking to regulate buy-back of securities.
Meaning of Buy-Back of Securities:
Buy-back of securities is similar to a company purchasing its own debentures for cancellation or redemption of preference shares. In the case of buy-back, the company which has issued shares to the public, buys-back or repurchases its own shares. Just as shares may be issued at par, at a premium or at a discount, re-purchase may also be effected at par, at a premium or at a discount. Buy-back of shares has the effect of reducing the company’s equity share capital to the extent of the par value of shares re-purchased.
Companies with surplus of cash, may resort to this method of paying the surplus back to its investors instead of paying the same as dividend. Redundant capital may be reduced and the risk of over-capitalisation may be avoided. This method may also be resorted to in order to increase the share value, by enhancing the earning per share.
Sources of Buy-Back of Securities:
Section 77A read with Section 77B (2) permits a company to buy its own shares or other specified securities out of:
(i) Its free reserves; or
(ii) The securities premium account; or
(iii) The proceeds of any shares or other specified securities.
However, no buy-back shall be made out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.
The expression ‘specified securities’ includes employees’ stock option or other securities as may be notified by the Central Government from time to time. ‘Free reserves’ means those reserves which, as per the latest audited balance sheet of the company, are free for distribution as dividend and shall include balance to the credit of security premium account but shall not include share application money.
Advantages of Buy-Back of Securities:
From the company’s point of view, buy-back have the following advantages:
(i) A company with capital, which cannot be profitably employed, may get rid of it by resorting to buy-back, and re-structure its capital.
(ii) Free reserves which are utilised for buy-back instead of dividend enhance the value of the company’s shares and improve earnings per share.
(iii) Surplus cash may be utilised by the company for buy-back and avoid the payment of dividend tax.
(iv) Buy-back may be used as a weapon to frustrate any hostile take-over of the company by undesirable persons.