A purchase of own shares or share buyback, takes place when a company purchases shares in itself from an existing shareholder and the shares purchased are not redeemable shares. This may be for example, because a shareholder is retiring from the company and cashing in his investment or he may be forced to sell following the termination of his employment. The shares are then (generally) cancelled and the issued share capital of the company is reduced accordingly.
However any share buyback procedure may only be made in accordance with the provisions of the Companies Act 2006 subject to any restrictions or prohibition set out in the company’s articles of association. Failure to comply with these specific requirements can lead to the buyback being declared invalid and potentially the directors being fined.
Shares subject to a buyback procedure must be in issue as fully paid. Private companies have the option to either purchase their own shares out of capital or distributable profits. The most common way for a company to finance the buyback of its shares is using distributable profits as a buyback out of capital requires the directors to swear a declaration of solvency and notice to creditors in the press and is therefore more complex and lengthy.