In recent years buying back company shares has become more popular than paying dividends for public companies. They do this to increase their share price. A private company can buy back shares as well. In a private company buy back the company pays stockholders for their shares instead of having one of the other shareholders buy the shares and increase their portion of ownership of the company. As with a public company buy back this generally increases the value of each share.
How to Buy Back Shares in a Private Company
When one or more shareholders want to exit a private company one option is for the company to buy back their shares. This can be done instead of one shareholder buying out another shareholder. When the buyback occurs, the company may pay remaining shareholders the market value of the shares that were bought back. Or, the company may choose to simply revalue existing shares and go forward with a higher stock price.
Why Buy Back Shares Instead of Dividend?
When a company pays dividends it does so with its profits which are taxed. Then, shareholders are taxed on the dividends that they receive. When a company buys back its shares this generally increases the value of their stock. This event does not trigger any taxation for the company or the shareholder and when the shareholder eventually sells their shares they are taxed at the long term capital gains rate and not the higher tax rate for ordinary income which is the rate applied to dividends.
How Can I Sell My Shares in Buy Back?
If a company decides to buy back shares it can work two ways. Public companies can simply go into the market where their stock is listed and purchase the desired number of shares. Alternatively, they can make a tender offer to any investors who are interested, giving a price range. Buyers will submit the price they wish to receive and the company will buy back shares at the lowest prices submitted. A private company does not go into the open market but rather determines the stock price for buy backs internally.
How Does a Company Buy Back Its Own Shares?
Publicly listed companies with excess cash commonly choose to buy back shares instead of payout out extra dividends. The most cost-effective way to do this is to purchase shares at the down times in the market where the stock trades. A company whose share price is lagging its fundamentals can do this and typically see the move boost its share price. Another route is to do a tender offer and state a price range. Shareholders submit the price they want to receive and the company chooses the lowest bids to buy back shares.
How to Account For Share Buy Back
Using the cost method of accounting, a company uses a treasury stock account to record the transaction. The amount paid to buy back stock is labeled as a debit. An equal amount is credited as cash as well. The treasury stock cannot be treated as an asset because companies can’t legally invest in their own stock. It is called a contra-equity account and reduces the total amount (in accounting) of owner equity.
How to Tell if a Company Is Buying Back Shares
If a public company is buying back shares on the open market they will report this on their quarterly statements. Thus you will only know about the share repurchases in retrospect. However, some companies will announce their intent to buy back shares in which everyone will be aware of the fact in advance. If the company places a tender offer to buy back shares then shareholders will be notified and have the opportunity to state a price at which they are willing to sell.
Why Companies Buy Back Their Shares
Why companies buy back their shares may be because they are doing very well and it may be because they are doing poorly. A company with a huge cash flow can let it build up, put it into R&D, buy out competitors, increase dividends, or buy back shares. A company whose share price is falling may choose to use cash on hand to buy shares in an attempt to reverse declining market sentiment. A private company will buy back shares when one of the investors wants to leave and not for any other reason.