Company can buy back its shares

JH writes: I run a small business that has been trading successfully for 25 years. My friend has held a 25% shareholding in the company since it began, but would now like to sell his stake. Having agreed a price for the shares, I was planning to purchase them myself over a period of time. However, my friend has suggested that the company invests in itself and purchases the shares in the same way as it would if investing in a quoted company. The logic is that the value of the company will stay the same, but this does not make sense to me or feel right. Please can you explain how this would work?

Your friend’s understanding of what happens when a company buys its own shares is not correct, writes Chris Lane, a partner at Kingston Smith LLP.

When a limited company purchases its own shares, instead of the company having an investment in the cost of the shares it intends to buy, the shares bought back are treated as cancelled. So if your company had 100 shares in issue beforehand and then purchased the 25% shareholding, there would only be 75 shares in issue afterwards and you would own 100% of the company. The distributable reserves of the company would be reduced by the cash outlay for the 25% holding, so your shares would have the same market value as they did before the transaction (assuming the price paid for your friend’s shares was equivalent to their market value).

The company’s articles of association need to be checked to make sure there is nothing to prohibit the buy back of its own shares and, if you wish to proceed, you would then need to follow a relatively straightforward procedure, including the preparation of a purchase agreement and the passing of a special resolution of the company approving such an agreement.

In terms of financing the purchase, should the company not have sufficient distributable reserves to fund the price agreed, and assuming it is a private company, the shares could be bought back out of capital. However, that involves a more complicated procedure and specific advice.

The nominal value of the shares purchased would be transferred to a capital redemption reserve fund.

There would also be stamp duty to pay on the purchase price of the shares at 0.5%, provided the consideration is above £1,000.