Buy back agreement

Standard option agreement between an employee-shareholder (such as a director) and a private limited company, providing for shares to be repurchased when employment ends.

Suitable for use in: England & Wales and Scotland
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About this document

There are a number of reasons why a company may buy back its shares from shareholders.

This agreement is intended to be used in conjunction with documents that give access to a share option scheme (such as an enterprise management incentive scheme) so that the company has the right, but not the obligation, to compel the employee to sell his or her shares when he or she ceases to be employed.

The party buying back the shares could be the company itself or an employee benefit trust.

Use of this agreement is much simpler than another way of achieving the same goal – amending the articles of association – which would also affect all other shareholders.

There are strict legal requirements which must be complied with. Where the company is a private limited one, the buyback can be funded by using:

  • distributable profits
  • the proceeds of a fresh issue of shares made specifically in order to fund the repurchase
  • using capital reserves
  • with spare cash up to the value of the lower of £15,000 and 5% of the company’s share capital

When using spare cash, shares must be bought at their nominal value. If a premium is paid, it must be done using distributable profits, except where the shares were originally sold at a premium, in which case the premium can be paid using proceeds of a fresh issue.

While shares bought back usually have to be paid for at the date of the transaction, if the reason for the purchase relates to an employee share scheme, payment can be deferred and made in instalments. This allows the company to manage cash flow more effectively given that it would not otherwise be aware of the employee’s intentions to leave in advance.

Any off-market purchase of company shares must be approved by the shareholders beforehand. In the case of employee shares being bought, shareholders need only give general authority to the means by which it will happen. Thus, if you set up an employee share scheme, it is important that the shareholders consent to how buybacks will be managed at the same time as consenting to the scheme itself.

Additional approval through use of notices is necessary when capital is being used to finance the transaction.

Accounting treatment

After the buyback, shares may be cancelled or held in treasury if purchased using distributable profits or cash, and must be cancelled if bought using the proceeds of a new issue of shares or with capital.

Any cancellation takes place immediately as soon as the shares are returned to the company. Issued capital is reduced by the same amount as the nominal value of the shares bought back.

Companies House and HMR&C should be notified of the transaction. Stamp duty is likely to be payable on the purchase price if the shares were bought for more than a nominal sum.

The company registers should be updated to reflect the cancellation of the shares.

A copy of the agreement must be kept for inspection by shareholders for a period of at least ten years from the date that the repurchase is completed or the date of the contract.

Draftsman

This document has been drawn by Rajeev Goswami, unconnected with Net Lawman. Rajeev Goswami will welcome your contact for further legal help. There may be a charge for Rajeev Goswami services.

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