Returning value to shareholders

Dividends, share buybacks and reductions of capital   

This article outlines some of the main ways to return value to shareholders before an exit and the circumstances in which this may be appropriate and desired.

Has your company recently:  

• achieved unexpected/significant profitability (eg from one-off contracts that landed in a particular year);
• sold part of its business or assets; or
• earmarked a pool of cash/resources (not required for day-to-day operations) for a proposed strategic investment or project that, for whatever reason, did not materialise or was aborted?

If so, your company may hold surplus cash that you, as shareholders, wish to be returned to you, whether by a dividend, buyback or reduction of capital (to name some options for returning value).

Alternatively, although a full exit is not on the horizon, is a shareholder looking to leave your company, for example, upon their retirement or a desired change of investment direction? If so, rather than the other continuing shareholders needing to find the resources to buy such shareholder’s shares, your company could, if distributable profits allow, buy back such shareholder’s shares or carry out a reduction of capital.

The ultimate return on your investment only comes from your sale proceeds when your company is sold. However, there are ways in which you can achieve returns from your company itself while continuing to own it. We have considered a few of these below.

Key features of dividends, share buybacks and reductions of capital  

• Dividend: this is the most common mechanic for returning value to shareholders. A dividend may be paid in cash or satisfied by the transfer of a non-cash asset of equal value to that of the dividend (a “dividend in kind” or a “dividend in specie”). In each case, the company must have sufficient distributable profits, ie at least equal to the value of the dividend. Dividends can be paid on a final year basis i.e. after the company’s profits for a particular financial year are known – subject to shareholder approval or an interim basis i.e. during a particular financial year – for most companies, payable by the directors without requiring shareholder approval.
• Share buyback: this is where a company acquires shares in itself from a particular shareholder. A buyback must be satisfied in cash and such cash can only be funded:

- from distributable profits;

- by the company issuing new shares to fund the buyback through the subscription monies for such shares; or

- for private companies only, out of capital.

The shares being brought back must be fully paid and the cash must be paid to the relevant shareholder at the point the buyback takes place, other than where the buyback is for the purposes of, or pursuant to, an employees’ share scheme.

Reduction of capital: this is where a company reduces the amount of its share capital and repays the reduced amount to its shareholders. The repayment may be in cash or in kind, but there is no set time period within which the repayment must be made once the reduction of capital has taken effect. The reduction may be achieved by:

• cancelling a certain number of shares in issue (including partly paid shares);
• reducing the nominal value of the issued shares, eg from £1 each to £0.10 each;
• cancelling the amount paid up on each share in issue (even if the shares are only partly paid); or
• reducing/cancelling a statutory reserve, eg a share premium reserve.

Differences and considerations – share buyback vs capital reduction

When thinking about returns of value, it’s important to consider the differences between share buybacks and capital reductions followed by a direct repayment to shareholders.    

• Generally, a share buyback may take place at any price, although there are certain requirements for listed companies. On a capital reduction, the repayment by the company may only be the aggregate amount of the paid-up nominal value of the shares cancelled. However, the repayment could be increased by the company also reducing/cancelling all or part of its share premium or other statutory reserve.
• A company must have sufficient distributable profits to fund a share buyback unless new shares will be issued to fund it or, for private companies only, it will be funded out of capital. Distributable profits are not required to undertake a capital reduction, however, the directors’ duties to the company will still apply. Their considerations and investigations of the company’s financial information, performance and prospects prior to giving the required solvency statement (see below) will need to be even more thorough and evidence-backed than for a capital reduction by a company with distributable profits.
• The company’s directors must give either a solvency statement or seek court approval for a capital reduction. A solvency statement is only required for a share buyback where it’s being funded out of capital.
• A capital reduction must be approved by a special resolution, but an ordinary resolution is sufficient to approve a share buyback, unless the company’s articles of association require a higher majority threshold). Market practice for listed and AIM companies is still to require a special resolution to approve a share buyback.
• No stamp duty is payable on a capital reduction. However, a company may be liable to pay stamp duty on a share buyback.
• The tax position  also needs to be considered and tax advice should be obtained before carrying out any return of value. The tax treatment (eg income tax, capital gains tax or no tax) of the amounts returned will be different for an individual shareholder than for a corporate shareholder and, in some cases, advance clearance from HMRC may be required. The Corporate Tax team here at TLT can advise you on the tax treatment and support you in navigating the tax process.