Share buybacks are often viewed as a straightforward financial manoeuvre. A company uses surplus cash to repurchase its own shares, reducing the number available on the market. The immediate effect is to increase earnings per share and, in many cases, support the share price. For directors, the appeal is clear: it looks like a simple way to reward shareholders and demonstrate confidence in the business.
Yet buybacks are not risk-free. Directors who treat them as routine transactions should be careful not to overlook non-obvious legal, financial, and tax challenges. In some cases, a poorly executed buyback can even expose directors personally. Therefore, care is required in proceeding with any buyback.
The legal framework under the Companies Act 2006
The starting point for any buyback in the UK is the Companies Act 2006 (the Act). The Act sets out strict rules designed to protect shareholders and creditors. Most buybacks require prior shareholder approval, usually in the form of an ordinary or special resolution. The company must also fund the purchase from distributable profits, or else follow a separate capital reduction procedure.
These steps are more than a box-ticking exercise. A buyback that does not comply with the Act can be declared void. Worse, directors may face personal liability if they authorised a transaction that was unlawful from the outset. Additionally, the reputational damage can be significant, especially if investors feel proper safeguards were ignored.
Financial pitfalls to avoid
The most obvious financial risk is the impact on cash flow. A large buyback can deplete reserves that might otherwise be used for investment or to weather economic downturns. In extreme cases, the drain on resources can tip a business towards insolvency. If insolvency follows, directors could face claims for wrongful trading if their decisions are judged to have worsened the company’s position.
There is also a broader debate about strategy. Critics argue that buybacks are often a “lazy” form of capital allocation. Instead of investing in research, innovation, or expansion, companies use cash to inflate the share price temporarily. While shareholders may welcome the short-term boost, it can be interpreted as a lack of ambition and damage long-term growth prospects. Consequently, directors should be prepared to justify why a buyback is the best use of funds.
Market and regulatory risks
Directors must also be mindful of how a buyback is perceived by third parties. If shares are repurchased at a time when the company holds inside information, regulators may treat the move as market manipulation. Timing is critical, as is ensuring that the market is properly informed about the purpose and scale of the buyback.
There is also the question of fairness. Shareholders who sell their shares back to the company may benefit in ways that others do not. Disputes can arise if some investors feel disadvantaged. Directors should ensure the process is transparent and that all shareholders are treated equitably.
Tax surprises from HMRC
Perhaps the least expected trap lies in tax. Many directors assume the proceeds of a buyback will be treated as a capital gain for shareholders. However, HMRC sometimes categorises the payment as income, which can result in differing tax treatment. The distinction depends on the circumstances, including whether the transaction is part of an overall restructuring or simply a return of surplus cash.
Directors who do not anticipate this outcome may face difficult conversations with shareholders who feel misled. In some cases, the perceived benefit of the buyback can be compromised entirely once the tax position is clarified.
The lawyer’s role
With so many potential pitfalls, specialist legal support is essential. Lawyers ensure the correct shareholder approvals are obtained and draft the agreements needed to implement the buyback. They can guide the directors in ensuring that the company has sufficient distributable profits and advise on the capital reduction procedure if required.
Beyond compliance, lawyers can also help directors consider the wider picture. They assess whether a buyback could expose the company to claims of market manipulation, and they liaise with tax advisers to anticipate HMRC’s likely stance. This proactive approach can reduce the risk of surprises and help directors demonstrate that they have acted with due care.
A share buyback may look like an easy way to deliver value, and they definitely offer advantages, but they have to be undertaken properly and with care. The process is tightly regulated under the Act, carries significant financial implications, and can generate unexpected tax outcomes. Directors who rush into a buyback risk more than disappointment – they may also face personal liability or damage the company’s reputation.
Before approving a buyback, directors should pause, weigh the alternatives, and seek expert legal advice. With the right guidance, a buyback can be managed safely and effectively.
If you have questions or concerns about share buybacks, please contact Jaan Larner.