Treasury shares: an opportunity for private equity?Print publication
The regime for the buyback of own shares changed on 30 April 2013 with the coming into force of the Companies Act 2006 (Amendment of Part 18) Regulations 2013. The changes could provide a warehousing opportunity for private equity backed companies.
We have described the changes to the buy-back regime in more detail elsewhere. For the purposes of this article, there are two aspects of the new regime we would like to highlight:
- private companies will be able to buy back shares using small amounts of cash (not exceeding the lower of £15,000 or the cash equivalent of 5 per cent of share capital in any financial year) which do not have to be specifically identified as being distributable reserves, so long as the articles of association expressly provide for this
- private companies and unlisted public companies will now be able to hold their shares in treasury. (Officially Listed companies were already able to do so.) To do so, the shares must have been bought back out of distributable profits or by utilising the small cash buyback option described above. Further, there must be nothing in the company’s articles to prohibit the shares being held in treasury. Such a prohibition may be implied as well as express, such as by the existence of a requirement that shares bought back must be cancelled.
Stamp duty is payable on buybacks where the shares are held in treasury at the normal rate (0.5 per cent unless the consideration is less than £1,000) and the company must be entered in the register of members as the holder of the shares. There are no legal limits to the number of shares a company can hold in treasury.
A warehousing mechanism will often be included in a private equity backed company’s articles of association in order to be able to satisfy the requirement to incentivise the successor to a departing manager. If the shares of the departing manager are not used for the purpose of incentivising the incoming manager (for example, they pass on pre-emption to the other shareholders) then difficulties may arise – an allotment of shares to the incoming manager will dilute the other shareholders; alternatively, if no allotment of shares is made to the incoming manager, he or she will probably expect an enhanced salary and other benefits instead, which will also impact on shareholder value.
There are various ways in which shares may be warehoused in order to incentivise an incoming manager without prejudicing the other shareholders. One of the most common is establish an employee benefit trust which would acquire the outgoing shareholder’s shares and then make these available to the incoming manager. However, these can be cumbersome and costly to establish and administer; these drawbacks may well outweigh the benefits, particularly where the number of shares to be warehoused is relatively small. An alternative is for the private equity investor to act as the warehouse. Again, there may be reasons why this is not practicable – possibly accounting or tax-based reasons. Managers may also be unhappy at the possibility of the warehoused shares simply being retained by the private equity investor.
The new ability for a private company to hold shares in treasury offers an alternative to both the warehousing alternatives described above. Effectively the company acts as the warehouse, holding the shares until the identity of the incoming manager is established and the shares made available to him or her.
Prior to the Companies Act 2006 (Amendment of Part 18) Regulations 2013 coming into force the simplest way of financing a buyback was through distributable profits. However, this could be a problem where the company is highly geared – which is often the case – or in the early lifetime of the company, before it starts to generate profits. The relaxation of the restrictions so that it is now possible to buy back with cash up to the value in any financial year of £15,000 or 5 per cent of its share capital may go some way towards solving or at least alleviating these potential problems.
Private equity providers should consider the possibility of using treasury shares as a warehouse when negotiating future investments. They should also ensure that the articles of association of new portfolio companies permit this. Consideration may also be given to whether existing articles of association for portfolio companies should be reviewed to maximise the opportunities provided by the relaxation on the rules on buybacks and the use of treasury shares.