Using capital for a redemption or purchase of own shares

When a private company wants to complete a share redemption or purchase of own shares it is initially required to use its existing distributable profits or the proceeds of a new issue.  In some cases there might not be sufficient distributable profits and the company may not want to issue new shares.  A private company can then fund the excess above the distributable profits out of capital.

The Companies Act 2006 does allow a private company to make a small payment out of capital of the lower of £15,000 and 5% of the aggregate nominal value of its fully paid share capital without any additional requirements.

If, however, this amount and any distributable profits are not sufficient to meet the planned redemption or purchase of own shares then the private company can make a permissible capital payment.  The amount of the permissible capital payment is the difference between the price paid by the company for the shares and the distributable profits of the company.

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Private companies will often look to make a permissible capital payment where an existing shareholder wants to leave the company (eg is retiring or leaving the company’s employment) or dies and the company does not have sufficient distributable profits for the purchase of own shares.

Permissible capital payment example

A shareholder of a company owning 20% of the shares dies and the other shareholders are unable to buy the shares.  In line with the shareholders’ agreement the directors therefore agree that the company should complete a purchase of own shares.  The deceased shareholder’s shares have been valued at £50,000.  This is, however, more than the company’s distributable profits of £21,985.

Therefore, to complete the purchase of own shares the company will have to make a permissible capital payment of £28,015.

Directors’ statement of solvency

For a private limited company to make a permissible capital payment the following needs to be completed by the directors before the purchase of own shares or share redemption is considered by the shareholders:

  • a review of the articles of association to ensure the purchase of own shares or share redemption can be made – these can, if necessary, be amended;
  • ensure that the shares being purchased or redeemed are fully paid and that there will be at least one non-redeemable share after the purchase or redemption;
  • agree the terms of the contract of purchase to be entered into with the seller(s) where applicable;
  • a statement of solvency that in their opinion, having made the payment the company:
    • should still be able to pay its debts as they fall due; and
    • for the year following the payment, having regard to their intentions for the company over that year, will be able to carry on business as a going concern and be able to pay its debts as they fall due.

In making this declaration the directors will need to have made a full review of the company’s financial status, current operations and future projections.  For this they should have prepared:

  • current accounts showing the company’s net assets;
  • business plans covering at least 15 months;
  • projected cashflow, including capital expenditure, covering at least 15 months;
  • projected net assets for the following year.

The company’s auditors, unless the buyback is part of an employees’ share scheme under The Companies Act 2006 (Amendment of Part 18) Regulations 2013 (Statutory Instrument 2013/999) (‘2013 Regulations’), are required to issue a report on the directors’ statement of solvency declaration.  This report should state that they are not aware of anything to indicate that the opinion of the directors in the declaration is unreasonable.

Shareholder approval

The shareholders must approve the share redemption or purchase of own shares out of capital by passing a special resolution.  This resolution should be passed at the same time as any resolution approving the terms of the purchase of shares. We have templates of the resolutions for purchase of own shares or share redemption out of capital that you can download.

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The directors’ statement of solvency and associated auditors’ report must be available for inspection at the meeting of the shareholders called to approve the purchase or redemption.  If the shareholder resolution is a written resolution then the directors’ statement of solvency and associated auditors’ report together with the terms of the purchase must be sent with the notice of the written resolution.

The special resolution must be passed on, or within one week after, the date of the statement of solvency.

Disclosing the proposed permissible capital payment

Unless the purchase is part of an employees’ share scheme under the 2013 Regulations, the company must within one week of the passing of the resolution:

  • Publish a notice of the proposed redemption or purchase of own shares out of capital in the London Gazette; and
  • Either publish notice of the proposed redemption or purchase of own shares out of capital in a national newspaper or notify all creditors.

In addition, the following must be filed at Companies House within 15 days of the date of the special resolution:

  • The directors’ statement of solvency;
  • The auditors’ report (where required); and
  • The special resolution.

Within five weeks of the date of the special resolution, any shareholder that did not vote for or consent to the resolution and any creditor may apply to the court to cancel the purchase of own shares or share redemption.  The court has wide powers to confirm, cancel or amend the purchase of own shares or share redemption on such terms and conditions as it thinks fit.

After the five weeks has expired without there being any application to the court the redemption or purchase of own shares can then be made. It must then be completed within seven weeks of the passing of the special resolution unless a court order has been made.

Once the redemption or purchase of own shares has been made the company needs to report this to Companies House.  For the share redemption this will be by completing and submitting form SH02.  For the purchase of own shares this will be by completing form SH03, getting it stamped, if necessary, by HMRC and then submitting this to Companies House together with form SH06 to notify Companies House that the shares have been cancelled.

What happens if the company is wound up within one year

If the company is wound up within one year of a payment for shares out of capital and the assets are insufficient to meet the company’s liabilities the seller of the shares and the directors who made the statement of solvency will be liable to contribute up to the amount of the capital payment.

A director will not need to make a payment if reasonable grounds for the opinion expressed in the statement of solvency can be shown.

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