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Funding a purchase of shares by private companies: ways around the problem

Frequently in share buybacks the question is asked: “Can we use borrowings (in whole or in part) to fund the purchase of the shares?”

Shares can be bought back out of distributable reserves (basically profits which could otherwise be used to fund dividends). They can also be bought back out of capital. The latter is more complex and therefore costly in terms of professional advice. Frequently smaller companies have an insufficient capital base to fund a substantial buyback out of capital which make it not practicable. Accordingly, buybacks out of distributable reserves are by far the most common route.

By definition borrowings cannot be profits. Also, the shares must be paid for when they are acquired by the company. Hence the problem.

However, there are several ways of achieving a buyback which is not only compliant but which also is tailored to the situation.

1.         The first is to stagger the purchase of the shares by way of several mini-completions. Completion of each tranche of shares will be dependent on profits existing at the relevant times, but provision can be made for deferral until sufficient profits have accrued. You will need to be aware that for capital gains tax purposes a disposal is triggered when a binding agreement for the sale is entered into, not when it is completed. However, that problem is easily overcome by using a series of put and call options instead of a contract which is binding on day 1. Under the cross-options, each can be exercised on a given date, but either the exercise of the option of its completion can be made conditional on the necessary profits existing.

2.         The second is to use loans which do not match the funds to be used in the buyback so that it cannot be said that the same monies are being re-circulated. This may require not only different amounts being loaned from those amounts to be used in the buyback but also timing differences. Advice should also be taken from the company’s accountant so that confirmation can be provided as to the existence of the necessary distributable reserves at the relevant time.

3.         The third alternative is to use the proceeds of a new issue of shares. This will not be possible if bank funding is to be used, but it can be used to good effect if other shareholder are willing to use their own monies to fund the exit of a fellow shareholder. The new shares to be issued can be of any class and could therefore be redeemable, with or without any other preferential rights, thus enabling the lender to be repaid without having to use the purchase of own shares regime.

A combination of the above methods can also be used, providing ideal flexibility for private companies and their owners.

If you would like to speak to someone further about the implications of the above then contact us by calling 0800 083 0815, or fill out an online enquiry form and a member of our team will get back to you.