Share Repurchase Agreement - Explained
What is a Share Repurchase Agreement?
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Table of ContentsWhat is a Share Repurchase?How does a Share Repurchase Work? Methods used in Share RepurchasePurchasing in the open market Repurchasing fixed shares at a fixed price Dutch Auction Repurchase by negotiating directly Reasons for Companies using Share RepurchaseShare Repurchase BenefitsAcademic Research on Share Repurchases
What is a Share Repurchase?
The share repurchase is when a public companys management decides to re-acquire its own shares. A company may re-acquire shares by purchasing them directly from the stock market. Alternatively, it may give its stockholders an option to directly offer their shares to the company at a set price. Another term used to refer to share repurchase is stock share or stock buyback.
How does a Share Repurchase Work?
Generally, a share repurchase reduces the number of outstanding shares. When the outstanding shares are reduced, it leads to an increase in demand and price. Instead of giving out dividends to shareholders, share repurchase serves as an alternative for the company to buy back shares using their own money. Buyback usually sends a price increase signal to the market so that financial metrics dominated by the outstanding shares is inflated.
Methods used in Share Repurchase
There are various methods a company can apply when it wants to implement share repurchase. The methods are as follows:
Purchasing in the open market
A company can re-acquire its shares directly from the open market. The shares are bought from the open market at the current market share price. The method is flexible as companies are free to buy shares at their own convenient time. Compared to other methods, the open market is regarded to be cost-effective.
Repurchasing fixed shares at a fixed price
Under this method, a company may place and offer involving a fixed price for a fixed number of shares. In such a deal, the prices of shares are usually higher compared to that of the market price. For instance, a company may offer a rate of $20 per share for 1 million shares. In case the shareholders agree to sell more shares than what they had offered, the company will buy the shares from different shareholders.
The Dutch auction is also another method through which a company can buy back its shares from the market. Note that this is almost the same as a fixed price purchase. However, instead of offering a fixed price, the company will give a number of acceptable prices. The price range usually includes a minimum and maximum figure.
Repurchase by negotiating directly
The method involves share price negotiation by the company. The negotiation is usually between large shareholders and the company. When the two parties reach an agreement, the company will buy the shares from the shareholders. The prices of shares under this method are usually higher compared to the current market rates. A company usually uses this method to help it keep away those large shareholders. Note that in most cases, large shareholders may take advantage of their large shares in the company to initiate a takeover. To prevent this, the company may use this method to buy shares from those with large shares. It enables the company to take away the privilege of owning large shares.
Reasons for Companies using Share Repurchase
Below are the reasons why a company may decide to engage in a buyback:
- To prevent a possible takeover by large shareholders
- To reduce or restrict the number of outstanding shares
- To gain flexibility when it comes to distributing cash to its shareholders
- Company implement share repurchase to be able to support the price of its shares
- Companies use share repurchase to help hide the decline of its net income
- For companies to fill the existing gap between dividends and excess capital. It ensures that the shareholders get good dividends at the end of the year.
Share Repurchase Benefits
Share repurchase has the following benefits:
- It ensures that the shareholders get back their money.
- It lowers the number of outstanding shares by increasing its price
- It makes investors believe that the company has extra cash and, therefore, chances of facing economic struggles are ensured. This attracts more investors.
Academic Research on Share Repurchases