Access to capital can be a critical driver for the growth and sustainability of virtually any business and one of the ways a company can access capital is by issuing shares. Money paid by investors or financiers to purchase units of ownership in a company, when aggregated, is the company’s share capital and a company seeking to acquire more funds to do business may increase its share capital, thus allowing current and new shareholders or investors to increase or acquire ownership respectively. Whilst investors in a public company can trade their shares on the stock exchange, a private company’s shares cannot be publicly traded; a shareholder in a private company may only transfer shares to another private individual, where there are no restrictions on such transfer. But did you know that a company can also buy its own shares and subsequently deal with those shares for value? Share repurchase can drive a business’ overall profitability and create value for its shareholders. The commercial and regulatory implications of this practice will be examined in more detail below.
A company repurchasing its shares (either by acquiring new shares or buying them back from existing shareholders) is basically a company reinvesting in itself. This practice is generally restricted, based on a fundamental principle of company law that a company must maintain and not reduce its capital. A company should ordinarily not finance the purchase of its own shares, either by using capital contributed by its shareholders, or by taking loans secured by its capital. To cite an analogy, a grocery trader who uses his business capital to purchase the same groceries stocked up for trading, will not be growing that capital, but rather ‘recycling’ it. This principle extends to restrict a company from giving assistance to a third party to purchase its shares, paying any dividends out of capital or enabling a subsidiary to purchase the shares of its holding company.
When a public company repurchases its shares, the repurchased shares are cancelled and this reduces the company’s share capital. For a private company repurchasing its shares, these are kept as treasury shares (shares in the reserve). When shares are repurchased in a private company, it gives the impression that new funds have been injected into the company through share capital enhancement, but in the real sense, the capital to run the company’s business has been reduced. Ensuring that such share repurchase does not create a misleading appearance of capital growth is what the regulators guard against.
Share repurchases under Nigerian Company Law
Under the now-defunct Companies and Allied Matters Act (CAMA) 1990, a company was not permitted to acquire or buy back its shares either from the open market or from existing shareholders. This was meant to serve the dual purposes of avoiding the reduction of the company’s capital and preventing incidents of fraud perpetrated by directors and shareholders repurchasing shares of their company to give an over-inflated image of the company’s performance.
In more advanced markets like the US and the UK, share buybacks are well recognized but are typically understood in the context of public companies whose shares are traded on the stock exchange. This perhaps explains the reason Nigeria’s Securities and Exchange Commission (SEC), in accordance with international best practice, had from time permitted a public company to buy back its shares from the open market upon the fulfilment of certain conditions – Rule 398 of the Securities and Exchange Commission Rules 2013.
With the coming into law of the CAMA 2020, private companies are now generally allowed to repurchase their shares and the company can enter its name in the register of members. As long as the company fully paid for the shares and the purchase is not from the capital of the company but its distributable profits, it can subsequently deal with those shares for value.
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Although the Securities and Exchange Commission Rules and Regulations 2013 (the SEC Rules) principally regulate share repurchases by public companies, most pre-and post-conditions for share repurchases set out by CAMA 2020 (Section 184 CAMA) also seem to mirror the SEC Rules. The Rules provide that public companies may repurchase their shares either from the open market (where the price is determined by the current market value of shares) or self-tender (where the price is determined by the Board and the price must not be fixed above 5% over the average market price of the shares). It is also worthy of note that shares repurchased by public companies pursuant to the SEC Rules cannot be kept as treasury shares but must be cancelled in accordance with the procedure for cancellation of shares set out in CAMA – Section 398 (3) (x) SEC Rules 2013.
Commercial considerations for private companies
Private company share repurchases are not done on a stock market, but in ‘off-market’ purchases and there are several commercial considerations which could trigger a company to repurchase its own shares:
1. To facilitate the buy–out and exit of a director/shareholder: Where a director/shareholder wants out of a company and would only resign further to compensation, the company can offer to purchase his shares at a market or fair price, especially where the other shareholders are not interested in buying the shares. The company can re-allot the shares sometime in the future to another shareholder.
2. Regulatory Compliance: Certain industries have regulatory prescriptions as to minimum share capital requirements for companies operating in the space. Companies may elect to increase their share capital in compliance with that prescribed minimum. The CAMA prescribes in Section 128(1) (a) that a company increasing its share capital must pay up at least 25% of said share capital to give effect to the increase. A private company may use treasury shares to map out the financing of the share increase.
3. Share acquisition for the purpose of an Employee Share Compensation Scheme: A company can consider holding a percentage of its shares to set up an employee compensation plan. Typically, under such a plan, employees would become entitled to the shares as a benefit after spending a certain period of time at the company. The company would hold shares in reserve for those of its employees who have not yet become eligible to access the benefit.
Commercial considerations for publicly traded companies in market purchases of their shares
‘Between 2021 and 2022, Dangote Cement Plc executed Tranche I and Tranche II of its share buyback program purchasing its shares in the open market through its stockbrokers and subject to prevailing market conditions and the daily trading rules of the Nigerian Exchange Limited (NGX). The shares of the company went up by 10% the day it announced its repurchase plan. This repurchase program was the first to be launched in Nigeria’.
While admittedly the Dangote brand may be considered a unicorn in Nigerian business, this example gives a sense of the kinds of benefits a company may derive from investing in its own shares. Here are a few scenarios where a publicly-traded company may want to repurchase its shares from the open market.
A publicly-traded company could buy its own shares in a bid to reduce the number of said shares available for trading; thereby raising demand, and by extension, the price of its shares in the market. A reduced number of shares in issue increases the Earnings Per Share (EPS) of each share, and the greater the EPS of each share, the greater its attractiveness to investors.
A public company can also repurchase its shares from the open market for the purpose of returning surplus cash to shareholders as an alternative to paying dividends.
Share repurchase can also be applied strategically as an anti-takeover mechanism. A company can choose to acquire its own shares to prevent a shareholder from acquiring a majority stake through a mandatory take-over process. By reducing the liquidity and number of shares available in the market, the value of the outstanding shares will be enhanced and the company’s exposure to such mandatory take–over is reduced.
Conclusion
The statutory leeway afforded for companies to purchase their shares offers greater flexibility to structure commercial transactions and drive an increase in the price of shares traded on the stock market. This consequently increases the value of those shares for the stockholders.
A share buyback program can also be used as a tax planning instrument. A share buyback financed from the distributable profits of the company gives the company the opportunity to distribute profits to its shareholders and this purchase will not be subject to withholding tax (dividends would have been subjected to withholding tax). The proceeds from the disposal of the shares by the shareholders will only be subject to Capital Gains Tax where the proceeds from the disposal are more than 100 Million Naira (N100, 000,000) in a consecutive 12-month period. The repurchase of shares is therefore a viable tool for a company as long as the repurchase does not offend the fundamental principle that capital must be maintained and there is no misrepresentation as to the capital standing and credit worthiness of the company.
