Returning value to shareholders has become a hot topic in recent years. With interest rates low, and limited acquisition opportunities, many companies have sought to keep investors happy by providing an income return when the prospects of significant capital growth have been low.
Why return value?
There are various reasons why a company may choose to return surplus cash to its shareholders:
- maybe the company raised funds for an acquisition which actually never took place;
- perhaps it disposed of a non-core subsidiary and has no immediate use for the resulting sale proceeds;
- maybe it is using a return as a tactical defence to an unwelcome takeover offer; or
- perhaps it’s just had a few good years of trading and has built up a cash reserve which it has decided to use to keep its shareholders happy rather than for reinvestment purposes.
How can value be returned?
Whilst the Government has closed the door on one potential method, (see our comments on the demise of the B share scheme in Autumn Statement: key changes to takeovers and shareholder returns), there are still various alternative routes by which a company can return value to its shareholders:
- Cash dividend
The simplest method involves the payment of a cash dividend to the shareholders. This could be done as a one off “special interim dividend” paid at the direction of the board. (Look out for our next blog on the restrictions which affect the payment of dividends and what happens if those restrictions are breached).
- Share buy-back
This route involves the company offering to buyback shares from its shareholders. Shareholders have a choice as to whether they participate, and receive the return of value, or whether they retain their shares, meaning their percentage shareholding in the company will increase as other shares are bought back and the overall share capital decreases.
- Reduction of capital
Both the payment of a dividend and a share buyback require the company to have sufficient distributable profits to cover the amount of the return. If a company has no such available profits, or it wishes to preserve them for future use, it could return value from its capital reserves via a reduction of capital. However, for public companies this would require court approval.
- Scheme of arrangement
At the more complex end of the spectrum is a scheme of arrangement involving the insertion of a new holding company into the existing corporate structure. If done correctly, this can result in the new holding company having much larger capital reserves than the original company which can then be used to effect a return via a capital reduction. A scheme of arrangement is a complex process which is probably only cost effective for large public companies wishing to make a significant return at a time when there are no distributable profits available or where the company has creditor protection issues.
Which method is the best?
There’s no hard and fast rule as to which of the above methods is the best and a number of factors will influence the company’s decision as to which one it uses:
- Tax – what are the tax consequences of each method, both for the company and the shareholders? Should the return be structured as a capital or income receipt in the hands of the shareholders?
- Reserves – does the company have distributable profits available? If not, its choices will be more limited.
- Timing – how quickly can the return be made and what are the factors affecting that timetable? Will any external consents be required?
- Amount – how much does the company want to return and how does it propose to fund that return?
- Flexibility – should shareholders have a choice as to whether they receive the return or should they all participate automatically?
Balancing the competing interests of these key drivers will decide which is the most appropriate method of returning value in each case.