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Where Would Fund From Buyback Get Credited

29 May 2023

What is a Share Buyback?

  • The term 'share buyback' (or share repurchase) refers to the purchase of the shares of publicly traded companies by their very owners.
  • This repurchase can either be from the secondary market or legal tender.
  • This practice is considered beneficial from a tax point of view, as the excess cash is returned to the investors, and they are rewarded. 
  • While the owner company offers this to all its shareholders, there is no obligation on the part of the shareholders to accept this offer.
  • The buy-back by the company is normally at a premium, so the offer is attractive to the present shareholders.

How Does a Share Buyback Work?

  • Companies generally declare a buyback to repurchase any portion of their shares that is outstanding from existing shareholders.
  • In a buyback, the company reduces the number of shares available in the market while simultaneously increasing its earnings per share. 
  • Increased earnings per share will lead to a jump in the price of the company's shares that are already on the market. Hence, the company’s financial position improves with the buyback of shares.
  • In turn, the increase in earnings per share can help shareholders sell some of their shares at a profit. This is a major benefit for the shareholders in the case of the buyback decided by the company.

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What are the Effects of a Buyback?

There are multiple effects, such as:

  • The buyback process reduces the net cash that is available to the company. This particular item gets noticed on the balance sheet too.
  • The financial position of the company is enhanced after the buyback of shares.
  • The earnings per share of the company increase after the buyback of shares.
  • The equity, which is the total assets minus the total liabilities of the company held by the shareholders, is reduced.

Which Account Gets Credited With the Buyback Proceeds?

To cite an example, consider a company that has excess cash of Rs. one crore and ten lakh outstanding shares. The company decides to buy back two lakh shares from the open market and designates Rs. 30 lakhs for the same.

The cash remaining after the buyback will be Rs. 70 lakhs (one crore minus 30 lakhs). The shares outstanding are 8 lakhs (ten lakhs minus two lakhs). The buyback will increase the earnings per share of the company and also gradually increase the price of the shares in the market.

The proceeds of the buyback are credited to the DEMAT account registered with the broker.

What are Some of the Key Reasons for Companies to Initiate a Buyback?

Some major reasons are as follows:

  1. Reducing liquidity:
    Sometimes excess liquidity is the reason for the buyback of shares by the companies. This is particularly done when the market is trending upward and is often seen as a sign of good financial health for the company.
  2. Tax benefits:
    Any proceeds that are earned from the buyback are non-taxable, making it a good option for the shareholders. The proceeds are usually higher because of the buyback at a premium.
  3. Consolidation of shareholders:
    When the number of shareholder groups in the company increases, it becomes difficult to manage. The decision-making process takes longer as the whole process is delayed. This can be a major reason for share buybacks. 

What are the Major Limitations of a Share Buyback?

Some of the major limitations are as follows:

  1. Misuse of cash reserve:
    Sometimes companies misuse the buyback purposefully for research and development, corporate social responsibility (CSR) initiatives, and such.
  2. Compensation is concealed:
    In the case of a buyback, sometimes the compensation is concealed in the form of employee stock ownership plans (ESOPs). This dilutes the holdings of the existing shareholders. 

Conclusion

  • To sum up, some investors and shareholders consider buybacks to be over-rated and over-hyped. 
  • On the other hand, it's also perceived as a tax-saving mechanism by many.
  • There are various opinions in the market, and you can view them the way you like.
  • The proceeds of the buyback are deposited in the registered Demat accounts of the company's shareholders.
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