OVERVIEW OF SHARE BUYBACK AND ITS LEGAL STATUS IN KENYA
Share buybacks refer to the repurchasing of shares by the company that issued them. Share buybacks have become common in the business world especially in the United States and Europe. Until recently, the concept of share buybacks in Kenya was foreign. The coming into force of the Companies Act, 2015 (the Companies Act) introduced this concept to Kenya with the aim of being the pioneers of this financial engineering in East and Central Africa. The Companies Act provides a unique opportunity to test the effects of legal regulation on companies financing decisions.
How should you carry out your share buyback?
If, after taking careful consideration of your competitive environment, you conclude that a share buyback will send the right message, you need to consider the following:
- The company’s articles should (a) not restrict shares buyback and (b) allow financial assistance by the company for the acquisition of its own shares. The articles may be amended to remove such restrictions by passing a special resolution;
- Any private agreements which may prohibit the company’s ability to purchase its own shares;
- Any pre-emption rights which may restrict the transfer of shares;
- The class of shares of the company. Variation of the rights case class will require prior consent;
- Banking facilities which might restrict the company’s ability to undertake a share buyback;
- A company must enter into a contract with the shareholder(s) whose shares are to be purchased. The terms of the contract should be approved by a special resolution of the company.
Financing the buyback
A buyback can be funded by any of the following means:
- Distributable profits;
- Proceeds of a fresh issue of shares made for financing the share buyback; or
- Out of capital.
The Companies Act has introduced provisions that set out the financing options and restrictions available for both private limited companies and public companies.
Advantages of share buyback:
- It boosts shareholder confidence in a company as the shareholder will view the purchase of shares by the company as a sign of confidence by the company.
- A company can take advantage of undervaluation by purchasing shares during undervaluation and once the market has corrected they can re-issue the shares thereby increasing its equity capital without issuing any additional shares.
- Share buybacks generally tend to reduce the overall cost of capital whereas returns in the form of dividends is a cost of equity.
- A shareholder who chooses to sell shares back to the company benefits from a ready buyer willing to take them at a premium.
- Purchasing an exiting member’s shares leaves the remaining shareholders with larger stakes in the company due to ownership consolidation.
- It is a new route to profits for companies.
- It’s an easy way to make a business look more attractive to short term investors as it is a quick fix for the financial statements since it boosts its financial ratios.
- A company's credit rating will be negatively affected if it is to borrow money to repurchase the shares
- The company may miss future opportunities due to the loss of capital e.g future dividends.
- Share buy buybacks taken up to take advantage of undervaluation may backfire.
- Share buybacks could open the door for listed companies to manipulate share prices.
Current legislation and legislative developments in Kenya.
Section 424 (2) of the Companies Act provides that a limited company can acquire any of its fully paid shares for a valuable consideration. Legislation on corporate share buy back has been well received by most companies who had expressed interest in taking up this option.
However, the regulators — the Capital Markets Authority and the Nairobi Stock Exchange — have opposed this legislation. Their current conservatism towards undertaking share buy-back stems from the fear that the move could open the door for listed companies to manipulate share prices.
They also have concerns that allowing companies to buy back their shares is equivalent to removing liquidity from the market. Such a consideration would go against the Nairobi Stock Exchange`s efforts to attract companies to list. The regulators are of the view that significant shareholders should only be allowed to buy their shares from the open market.
The changing legal regulation of commercial terms has led to the need of engagement between stakeholders in the legal and finance sectors. It was therefore prudent that the share buyback legislation be held back by the Attorney General of Kenya to allow for engagement between relevant stakeholders and thereafter amendments will be proposed for adoption. Kenya has suspended a law on share-buy backs by listed companies. At the time of incorporation, the law allowed public companies to repurchase their own shares from the capital market.
There has been significant debate on how the provisions of the Companies Act dealing with share buybacks will affect business in Kenya with an outcry that they must be urgently amended to encourage major shareholders in listed companies to buy shares from the open market.
As consultations are ongoing, legal regulation of share buy-backs needs to be simplified making it considerably easier for companies to repurchase their shares. Stringent regulation of share buy-backs make them less effective since companies will be reluctant to undertake them because they believe that they are either not favored, viewed negatively or not understood by shareholders.
Kenya has suspended a law on share-buy backs by listed companies. Currently, there are no regulations that govern share buyback transactions, neither have prescribed forms been issued. We continue to watch whether this provisions in the Companies Act dealing with share buybacks, which have attracted significant debate, will remain suspended or will be amended.