Share buyback in instalments

Can a company pay for a share buyback in instalments if it cannot afford to pay the seller in one lump sum?

Yes. A company can structure a share buyback with payments made in instalments. However, the arrangement must comply with the relevant legal requirements, and there are important procedures and potential pitfalls to consider.

Structuring share buybacks in tranches

Share buybacks are fairly common and can be a useful way to resolve shareholder disputes. However, disputes often arise when the company lacks the cash to buy back shares in one payment.

A company must generally pay for shares in full on purchase. It must also have sufficient funds available from permitted sources, such as distributable profits or the proceeds of a fresh issue of shares made for that purpose. Directors should consider whether the company can meet its liabilities after the buyback.

One advantage of the buyback regime is that it is possible to apply to HMRC for advance clearance on whether the transaction is expected to qualify for capital treatment, subject to the statutory conditions.

Where a company cannot fund the entire buyback at once, a multiple-completion structure may allow the shares to be purchased in separate tranches, with each purchase paid for on completion. We can help structure the transaction to provide the required flexibility.

Structuring a share buy back in instalments

First, the directors agree the price and number of shares to be purchased in each tranche. Valuing shares in a private company can be difficult where there is no market price. The directors should then review the company’s cash flow forecasts and available funds to establish whether each tranche can be completed lawfully.

Share buybacks - hidden traps

We commonly encounter five risks. There are others, but these are among the most common:

• Retention of rights in shares – The documentation must establish when each tranche is purchased and the seller’s rights in relation to any shares not yet transferred. Where capital treatment is sought, the seller’s continuing voting rights and involvement may be relevant to HMRC’s assessment.
• Tax problems – If the seller does not satisfy the relevant HMRC conditions, the payment may be taxed as a distribution rather than a capital receipt, potentially resulting in a higher tax liability.
• Has the company bought back sufficient shares on day one? – For the substantial reduction test, the seller’s interest immediately after the purchase must generally be no more than 75% of their interest immediately before it. The calculation must take account of the shares cancelled and the resulting reduction in issued share capital. Each tranche must be considered in its own context.
• Does the departing shareholder remain a director until all instalments are paid? – The seller’s continuing role and control may affect the availability of capital treatment. The position should be assessed against the statutory conditions; resignation may be appropriate in some circumstances but is not an automatic requirement.
• Misjudging the required cash flow – The company must have sufficient funds from permitted sources to complete each purchase and pay the price when due. The parties should consider what happens if forecasts are not met and whether the proposed structure provides a workable solution without breaching the legal requirements. The seller may also seek security, which the company may be reluctant to provide.