Share buyback explained
A buyback is when a company offers to re-purchase some of its shares from existing shareholders.
The net effect is a reduction in the total number of a company’s shares on issue. This is generally seen as a way for companies to boost shareholder returns because after the buyback a company’s profit will be spread across fewer shares.
Consequently, a buyback announcement usually sees share prices rise.
Why do companies buy back their own shares?
Boosting shareholder returns is just one of the reasons companies may choose to engage in a buyback.
- Using surplus cash the company doesn’t plan to use for acquisitions
- Making a change to the company’s capital structure. This is because changing the amount of shares on issue will have an impact on things like the company’s ratio of debt to equity
- Giving a boost to shares if the company feels they are undervalued
What are the different types of buybacks?
- On-market buybacks are when a company buys its own shares on an exchange in the ordinary course of trading.
- Off-market buybacks refer to buybacks that do not occur on an exchange, but rather when the company makes its offer direct to shareholders.
An off-market buyback can either be ‘equal access’, which gives all ordinary shareholders the option to participate, or ‘selective’, which is when the company offers to buy back shares from a particular group of shareholders. This latter option requires a shareholder vote, with those who are part of the selling group excluded from voting.
Share buybacks carry tax implications, which are worth consideration, and are why companies announcing a buyback will generally suggest seeking some form of advice.
In the case of an on-market buyback, an investor will make either a capital gain or a capital loss, depending on what was paid for the asset.
A capital gain needs to be declared on your tax return and added to income, while a capital loss can be carried forward to offset other capital gains.
Off-market buybacks tend to be slightly more complex as many have a franked dividend component.
This franked dividend component changes an investor’s capital gain, but can also provide some tax benefits, depending on the marginal tax rate you pay.