Business finance - Share buybacks

Learning Outcomes

This article outlines the law and practice of share buybacks under the Companies Act 2006, including:

• The statutory framework in Part 18, distinguishing on-market and off-market buybacks for private and public companies, and the role of the articles.
• Permitted funding sources, mandatory sequencing of profits, fresh issue proceeds and, for private companies, limited use of capital, plus the creation and purpose of the capital redemption reserve.
• The step-by-step procedural requirements, shareholder approvals, voting exclusions, inspection rights, and filing/record‑keeping obligations (SH03, statement of capital, notice of cancellation and contract retention).
• Directors’ duties, conflicts of interest, solvency and fairness assessments, and how these influence the board’s decision to approve a buyback.
• Capital maintenance and creditor protection mechanisms, including the solvency statement procedure, publicity and objection rights when paying out of capital, and consequences of non‑compliance.
• The availability and limits of treasury shares for public companies, mandatory cancellation for private companies, and special rules for small buybacks and employee share schemes.
• How these rules are tested in SQE1‑style multiple‑choice questions and scenario‑based problems, and common traps that lead to invalid buybacks or director liability.

SQE1 Syllabus

For SQE1, you are required to understand the legal and practical aspects of share buybacks as part of business finance, with a focus on the following syllabus points:

• The statutory framework for share buybacks under the Companies Act 2006 (Part 18), including the general prohibition and permitted exceptions
• The capital maintenance principle and funding restrictions for buybacks (profits, fresh issue proceeds, and private companies’ limited use of capital)
• The procedural requirements for private and public companies (on-market and off-market buybacks)
• Directors’ duties when authorising buybacks, including conflict management and solvency considerations
• Shareholder approval mechanics, voting exclusions, inspection rights, and disclosure obligations
• Post-completion filings, record-keeping and cancellation requirements (return of purchase, statement of capital, and retention of contract)
• The capital redemption reserve and its effect on the balance sheet
• Treasury shares for public companies and cancellation requirements for private companies
• The consequences of non-compliance and the impact on creditors and shareholders, including potential personal liability
• Variations for small buybacks and employee share schemes, and creditor objection rights when paying out of capital

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What are the main funding sources a private company can use for a share buyback?
2. Which shareholder(s) are excluded from voting on an ordinary resolution to approve an off-market buyback?
3. What is the purpose of the solvency statement procedure when a private company funds a buyback out of capital?
4. What are the consequences if a company fails to comply with the statutory procedure for a buyback?
5. How do directors’ duties under the Companies Act 2006 affect decisions to buy back shares?
6. When may repurchased shares be held in treasury, and by which type of company?
7. What filings must be made at Companies House after a buyback and what record must the company retain?

Introduction

A share buyback occurs when a company purchases its own shares from shareholders. This reduces the number of shares in issue and can have significant effects on the company’s capital structure, shareholder value, voting control, and creditor protection. The Companies Act 2006 sets out strict rules to ensure that buybacks are carried out lawfully and do not undermine the interests of creditors or other stakeholders.

Buybacks interact closely with the principle of capital maintenance: a limited company’s share capital is intended to be a stable fund for creditors, and returns of capital to shareholders are tightly controlled. Because buybacks alter the number of shares in circulation, they also alter percentage holdings. A buyback often increases the relative voting power of remaining shareholders, so governance consequences must be assessed alongside funding and solvency.

Statutory Framework for Share Buybacks

The Companies Act 2006 (CA 2006) governs share buybacks in Part 18. A company may only buy back its own shares if permitted by its articles of association and if it follows the statutory procedures. There is a general prohibition on a company acquiring its own shares other than as permitted by Part 18, reflecting capital maintenance concerns. The Act distinguishes between on-market and off-market purchases and imposes different approval and disclosure requirements.

Key Term: share buyback
A transaction where a company purchases its own issued shares from shareholders, reducing the number of shares in circulation.

Key Term: capital maintenance
The legal principle that a company’s share capital must be preserved as a fund for creditors and cannot be returned to shareholders except as permitted by law.

A limited company may buy back its own shares subject to statutory conditions. The shares must be fully paid, the company must continue to have at least one non-redeemable share in issue, and the buyback must be funded from permitted sources and authorised by shareholders where required.

Types of Buyback

There are two main types of buyback:

• On-market buybacks: For public companies, purchases made on a recognised investment exchange, typically authorised by an ordinary resolution that sets parameters such as maximum number of shares and pricing. On-market buybacks engage market-facing obligations (e.g. disclosure and price discipline) and may allow public companies to hold repurchased shares in treasury.
• Off-market buybacks: Purchases made by private or public companies otherwise than on a recognised investment exchange, usually by private agreement. These require a buyback contract and shareholder approval in a defined form, and are common in private companies where shares are illiquid.

Key Term: on-market buyback
A purchase by a public company of its own shares on a recognised investment exchange, under a shareholder authority that sets parameters and is subject to market rules.

Key Term: off-market buyback
A purchase by a company of its own shares otherwise than on a recognised investment exchange, typically by private agreement.

Funding Restrictions

A company may only fund a buyback using certain sources:

• Distributable profits: Most common for both private and public companies.
• Proceeds of a fresh issue of shares: The company issues new shares and uses the proceeds to fund the buyback, preserving overall capital.
• Capital: Private companies may, in limited circumstances, use capital for a buyback if they follow the solvency statement procedure and creditor/publicity requirements.

The law requires strict sequencing: if a private company proposes to fund a buyback from capital, it must first apply any available distributable profits and proceeds of a fresh issue to the purchase price; only the shortfall may be met from capital. Where the buyback is funded from profits, the nominal value of the shares purchased must be transferred to a capital redemption reserve to preserve the creditors’ fund.

Key Term: distributable profits
Profits available for distribution to shareholders, calculated as accumulated realised profits less accumulated realised losses.

Key Term: solvency statement
A formal statement by the directors confirming that the company can pay its debts as they fall due and will remain solvent for at least 12 months after the buyback, supported by an auditor’s report in the payment-out-of-capital procedure.

Key Term: capital redemption reserve
A non-distributable reserve created when a company buys back or redeems shares out of distributable profits, equal to the aggregate nominal value of the shares cancelled.

Some limited variations exist for small buybacks by private companies and employee share scheme shares, but the fundamental funding and approval discipline remains. Stamp duty may be payable on the buyback consideration.

Procedural Requirements

The procedure for a buyback depends on whether the company is private or public, and whether the buyback is on-market or off-market.

Private Companies

• The articles must not prohibit buybacks.
• The company must enter into a buyback contract, which must be approved in advance by an ordinary resolution of the shareholders (CA 2006, s. 694). The resolution may also approve a proposed contract conditional on approval. Any variation to approved terms must itself be approved by ordinary resolution.
• The shareholder whose shares are being bought back cannot vote on the resolution. Where multiple shareholders are selling, none of them may vote.
• The buyback contract (or a summary) must be available for inspection by shareholders at least 15 days before the meeting; if a written resolution is used, the contract terms must be circulated to eligible members before the written resolution is proposed.
• Payment must be made only for fully paid shares. The company must continue to have at least one non-redeemable share in issue after completion.
• The company must file a return of the purchase within 28 days (including a statement of capital and, if the shares are cancelled, notice of cancellation). The contract must be kept available for inspection at the registered office for 10 years.
• Shares purchased by a private company must be cancelled on purchase; private companies cannot hold repurchased shares in treasury.
• If funding from capital, the directors must make a solvency statement, supported by an auditor’s report, and a special resolution must be passed to approve the payment out of capital (CA 2006, ss. 709–723). Notices must be published in the Gazette and either in a national newspaper or sent to each creditor. Objecting shareholders (who did not vote in favour) and creditors may apply to court to cancel the resolution within the statutory window. The buyback cannot proceed for at least five weeks after the special resolution, allowing time for objections.

Key Term: buyback contract
The off-market agreement under which the company agrees to purchase specific shares, whose terms must be approved by ordinary resolution and made available for inspection.

Public Companies

• Buybacks must be made either on a recognised investment exchange (on-market) under a shareholder authority or by an off-market offer to all shareholders on the same terms (CA 2006, s. 701).
• The company must have sufficient distributable profits or use the proceeds of a new share issue; public companies cannot fund buybacks out of capital.
• Additional disclosure and reporting requirements apply, including market notifications, compliance with listing rules and UK MAR (market abuse regime), and timely filings at Companies House.
• Public companies may, subject to statutory limits, hold repurchased shares in treasury rather than immediately cancelling them. Treasury shares do not carry voting or dividend rights until reissued.

Key Term: treasury shares
Shares repurchased and held by a public company in treasury rather than cancelled; they carry no voting or dividend rights until reissued, allowing flexibility in capital management.

Directors’ Duties and Share Buybacks

Directors must comply with their statutory duties when authorising a buyback, in particular:

• Duty to act within powers (s. 171): Directors must act in accordance with the company’s constitution and only exercise powers for proper purposes, including ensuring the buyback is permitted by the articles and Part 18.
• Duty to further the success of the company (s. 172): Directors must act in good faith for the benefit of the company as a whole, considering the long-term consequences, employees, creditors, and fairness between members. Buybacks that materially alter control or reduce liquidity require careful assessment.
• Duty to exercise reasonable care, skill, and diligence (s. 174): Directors must properly assess the financial impact of the buyback, the availability of funding sources, and solvency, and seek advice if needed.
• Duty to avoid conflicts of interest (s. 175): Directors selling their own shares to the company or participating through connected persons must manage conflicts; a director should declare interests (s. 177) and abstain from relevant shareholder votes where excluded by statute.

Key Term: directors’ duties
The statutory and common law obligations imposed on company directors, including acting in good faith, with care, and for proper purposes.

A thorough board paper should document the financial analysis, funding source, solvency assessment, rationale, and relevant stakeholder considerations to demonstrate compliance with duties.

Shareholder Approval and Disclosure

For off-market buybacks, an ordinary resolution is required, and the buyback contract must be made available for inspection. The selling shareholder(s) are excluded from voting. If the terms are varied, a further ordinary resolution is required.

Public companies must also comply with disclosure requirements, including notifying the market, and filing returns at Companies House. Treasury share holdings and transactions must be reported. All companies must file a return of the purchase and, where the shares are cancelled, a statement of capital and notice of cancellation within statutory time limits. The buyback contract must be retained for inspection for 10 years.

Capital Maintenance and Creditor Protection

The capital maintenance principle restricts the sources of funds for a buyback to protect creditors. Private companies may use capital only if they follow the solvency statement procedure, which requires directors to confirm that the company will remain solvent after the buyback. Available distributable profits and fresh issue proceeds must be used first; only the shortfall is met from capital.

Where a buyback is funded from distributable profits, the nominal value of the shares purchased is transferred to a capital redemption reserve, ensuring the creditors’ fund is preserved. The overall accounting effect typically includes a reduction in issued share capital (by the nominal value of cancelled shares), a corresponding increase in the capital redemption reserve, and reductions in retained earnings and cash by the total consideration paid.

Creditor protection is reinforced by the publicity and objection rights in the payment-out-of-capital procedure. If a company fails to comply with procedure or funds a buyback from an impermissible source, the transaction may be void, amounts paid may be recoverable, and directors may face personal liability and criminal sanctions.

Tax and Regulatory Considerations

Buybacks may have tax implications for both the company and the selling shareholders. For private companies, proceeds may be treated by HMRC either as a distribution or, in limited circumstances where statutory conditions are met (e.g. trading company and substantial reduction in shareholder’s interest), as capital for CGT purposes. Stamp duty at the applicable rate may be payable on the buyback consideration. Public companies must also comply with market abuse regulations and, in some cases, the Takeover Code, including disclosure and price disciplines in buyback programmes. Legal and accounting advice should be sought to ensure compliance.

Worked Example 1.1

A private company wishes to buy back 10% of its issued shares from a retiring shareholder. The company has sufficient distributable profits. What steps must the company take to lawfully complete the buyback?

Answer:
The company must check its articles allow buybacks, enter into a buyback contract, and obtain shareholder approval by ordinary resolution (excluding the retiring shareholder from voting). The contract must be available for inspection 15 days before the meeting (or circulated before any written resolution). Payment must be made for fully paid shares. After completion, the company must file the return of purchase (including the SH03 and the statement of capital with notice of cancellation) within the statutory time limit, cancel the shares (private companies cannot hold treasury shares), and update the register of members. The nominal value of the cancelled shares must be transferred to the capital redemption reserve.

Worked Example 1.2

A private company wants to fund a buyback out of capital. What additional requirements apply?

Answer:
The directors must make a solvency statement, supported by an auditor’s report, confirming the company can pay its debts and will remain solvent for 12 months. A special resolution must be passed to approve the payment out of capital, within seven days of the directors’ statement. Notices must be published in the Gazette and either in a national newspaper or sent to each creditor. Objecting shareholders (who did not vote in favour) and creditors may apply to court to cancel the resolution within the five-week window. The buyback must not proceed for at least five weeks after the special resolution, allowing time for objections. Available distributable profits and proceeds of a fresh issue must be applied first; only the shortfall can be met from capital. Post-completion filings and cancellations must then be made.

Worked Example 1.3

A public company proposes to buy back shares on the stock exchange. What are the key legal requirements?

Answer:
The buyback must be authorised by the articles and by an ordinary resolution under which the company may purchase on a recognised investment exchange with defined parameters (e.g. maximum number and price range). The company must use distributable profits or the proceeds of a new share issue. The company must comply with market disclosure and reporting requirements and file returns at Companies House. Repurchased shares may be held in treasury subject to statutory limits and market rules or cancelled. The programme must comply with UK MAR and relevant listing rules.

Worked Example 1.4

A private company proposes to buy back shares from a director–shareholder who is retiring, using distributable profits. What conflicts and approvals arise?

Answer:
The buyback requires an off-market contract approved by ordinary resolution, with the selling director–shareholder excluded from voting. At board level, the director should declare their interest (s. 177) and abstain from any decision where appropriate; the board must document compliance with s. 172, s. 171, and s. 174 duties, including consideration of solvency and fairness between members. The contract must be made available for inspection. After completion, the company files the return and cancels the shares, transferring the nominal value to the capital redemption reserve.

Worked Example 1.5

A private company wants to conduct a small buyback to tidy up its shareholder base. It has limited distributable profits. Are there any limited exceptions that assist?

Answer:
Private companies generally fund buybacks from distributable profits or fresh issue proceeds and, if necessary, follow the payment-out-of-capital procedure. Limited statutory variations exist for small cash buybacks and certain employee share scheme purchases, easing approval mechanics and permitting small payments in specific circumstances. However, the company must still comply with the off-market contract approval, voting exclusions, inspection, and filing requirements. If a small buyback exception is used, the company must ensure it remains within the statutory monetary/percentage cap and documents the basis clearly.

Exam Warning

Directors must ensure that the company remains solvent after a buyback. If a buyback is funded out of capital without following the solvency statement procedure, the transaction is void and directors may be personally liable for losses. Failure to approve the off-market contract correctly (including voting exclusions and inspection) or to file required returns and cancellations can also invalidate the buyback and expose directors and the company to sanctions.

Revision Tip

Always check the company’s articles for restrictions on buybacks and ensure all statutory procedures are followed. Verify funding sources and, for private companies, whether capital may be used and the solvency statement procedure engaged. Remember that public companies may hold repurchased shares in treasury; private companies must cancel. Keep a copy of the buyback contract available for inspection for 10 years and update registers and filings promptly.

Key Point Checklist

This article has covered the following key knowledge points:

• A company may only buy back its own shares if permitted by its articles and if it follows the Companies Act 2006 procedures.
• Buybacks must be funded from distributable profits, proceeds of a new share issue, or (for private companies) capital using the solvency statement procedure; the sequencing of funding is mandatory.
• Off-market buybacks require an ordinary resolution approving the contract, with selling shareholder(s) excluded from voting and inspection rights observed.
• Directors must comply with their statutory duties, including acting in good faith and considering creditor protection, and must manage conflicts of interest.
• Capital maintenance rules protect creditors by restricting the sources of funds for buybacks; the capital redemption reserve preserves the nominal capital where profits fund the buyback.
• Public companies may buy back on-market under shareholder authority and may hold repurchased shares in treasury; private companies must cancel repurchased shares.
• Post-buyback filings include the return of purchase and statement of capital with notice of cancellation; the buyback contract must be retained and available for inspection for 10 years.
• Failure to comply with the statutory procedure can render the buyback void and expose directors to liability; creditors and certain shareholders can object to payments out of capital.

Key Terms and Concepts

• share buyback
• capital maintenance
• distributable profits
• solvency statement
• off-market buyback
• on-market buyback
• buyback contract
• capital redemption reserve
• treasury shares
• directors’ duties