Resources of Buy Back

A Company can purchase its own shares from

i. Free reserves; Where a company purchases its own shares out of free reserves, then a
sum equal to the nominal value of the share so purchased shall be transferred to the
capital redemption reserve and details of such transfer shall be disclosed in the
balance-sheet or
ii. Securities premium account; or
iii. Proceeds of any shares or other specified securities. A Company cannot buy back its
shares or other specified securities out of the proceeds of an earlier issue of the same
kind of shares or specified securities.

OR

RESOURCES OF BUY BACK:

The companies amendment act 1999 under section 77A prescribes for the sources of buying back
of shares or other specified securities by a company, which are as follows-:

i) Free reserves- a company may buy back out of its free reserves but a sum equal to
the nominal value of the shares so purchased must be deposited in the capital redemption
reserves account.
ii) Securities premium account.
iii) The proceeds of any shares or specified securities.

No buy back of any shares or securities shall be made out of the proceeds of an earlier issue of
the same kind of shares of same kind of securities

Capital Structure after Buyback

Effects On The Company
ASSUMPTIONS
CASE 1: the original proportion of promoters and non promoters share in the total equity capital
was 33.33% and 66.67%. We are assuming that there is a 100% buyback of 25 shares which the
company has proposed to make. Therefore all the shares that are proposed to be bought are
bought from the no promoters group and nothing has been offered by promoters. Thus the
proportion of promoters share in the total equity capital increases from 33.33% to 40%.

CASE 2: Here the company decides to keep the shareholding same as before i.e. promoters
33.33% and Non promoters 66.67%. As the company has offered to buy back 25 shares, to
maintain the same shareholding pattern promoters has to offer 8 shares of their own and the rest
would be the net offer to the public i.e. 17 shares.

CASE 3: In this case the company decides to bring down the promoters shares in the company’s
equity share capital to 25%. That means promoters have to offer 19 shares and net offer to the
public would be only 6 shares. Therefore we can say that depending on the policy of the
company the shareholding pattern of the company changes. Promoters share can increase
decrease or remain the same.

Effects On The Shareholder

Tax Benefits: When a company has surplus cash, they can either pay it off as dividend or buy
back shares. When a company pays dividend they are entitled to pay tax at the rate of 15%. This
cost has to be borne by shareholders, who receive less cash then what is declared. Therefore by
Buying back shares, company gives surplus cash to the shareholder and saves tax for the
shareholders.
Example: A company has surplus cash of Rs.150 crore and if they declare Rs.150 crore as
dividend then company has to pay tax of Rs.22.5 crore. So the net amount which would be
received by the shareholder would be Rs.127.5 crore.
If a company decides to go for buyback of shares then the entire amount of Rs.150 crore is
received by the shareholder. Thus shareholders save tax of Rs.22.5 crore, which they would have
incurred, if the company would have given them surplus cash by way of dividend.
Higher Proportion of share: When a company goes for buyback, number of shares outstanding
reduces. That means proportion of an individual investor increases. This can be explained with
the help of an example:
A company which has 1000 outstanding shares goes for buyback of 250 shares. So after 100%
buyback, company would have 750 shares outstanding. If an individual investor has 50 shares
then its proportional share in the company’s total paid up equity share capital would be 5%
before buyback and after buyback it would be 6.67%. Thus there is an increase in his/her
proportional share.
Higher Share Price: One of the reasons why a company goes for a buyback is that they think
that their shares are undervalued. That is why they buyback share at a premium or at a price that
they think it should command in the market.
For example, a company market price of the share is Rs.500 and company believes that the price
of their share should be at Rs.600 based of their fundamental and technical analysis. Therefore
company buys back share at Rs.600 from the market and thus increasing the market value of the
share from Rs.500 to Rs.600.