A repurchase option is a term used when a company originally issues stock shares.3 min read
Updated July 14, 2020:
A repurchase option is a term used when a company originally issues stock shares. It allows the company to repurchase the shares from the shareholders who own them at a later date. A repurchase option may be used for a number of reasons by a company. Some of the results that can occur from this type of arrangement include:
- Providing liquidity to the departed
- Permitting the surviving to retain all of the ownership
- Preventing those who are less desirable from being shareholders in the company
Some stockholders may wish to have a repurchase option be mandatory in the event of disability or death because they might see a need for possible liquidity. They also may want there to be the optional right in the event the company is sold to a third party. This way, the company may not be forced to make a payment it can't afford but still has security to prevent the risk of being sold to a competitor.
Repurchase rights are often utilized by startup companies that may wish to issue what is referred to as common stock, which is issued to the founders of a business when it is formed. When a repurchase right is offered, there is often a structure in place that allows the repurchase to occur only during a preset time period.
Differences Between a Repurchase Right and Vesting
There are many differences between a standard repurchase right and vesting.
- With a repurchase right, a shareholder owns the stock that is subject to repurchase. When stock options are vested, the option holders do not have any rights to the stock.
- A repurchase right gives the originating company the right to buy back the sold stock from the shareholders if certain conditions are met. The company does not have to exercise the right, and if it doesn't, the shareholder retains the rights to the stock.
- When the options are subject to vesting, the company will not have to take an action if the employee is fired or chooses to leave the company. These options revert back to the company automatically.
- When you have a repurchase option, the stocks are typically sold back at the price they were purchased at. In some cases, the value may be tied to what the current shares are valued at on the market.
What Happens When Repurchase Rights Are Exercised?
Under many repurchase right agreements, the right to repurchase can fall to multiple parties. This usually occurs in a waterfall-type structure. The company retains the right of first refusal to repurchase the shares, but if it exercises this right, it will next shift to other investors in the company. If parties with the right to repurchase option choose to repurchase, then the shareholder will keep their shares.
There are many situations where both the investors and the company will allow the repurchase right to expire, especially if the company is doing well. An example of this could be when a founder is asked to step down from the role of CEO, but it is done on an amicable basis.
A repurchase right decision is often made by the board of directors, though it might be done by a voting agreement or other procedure the company has set forth. There can be conflicts of interest for the board to consider in the event of a repurchase option. The shareholder who is leaving may have a board seat, which would make them one of the decision-makers when it comes to the repurchase right option.
Equity Reallocation Without an Agreement
If there is no agreement in place for how repurchase rights will be handled by the company, then there may need to be a negotiation or the company may need to find a way to dilute a nonperforming or departing founder. Negotiated results are often not in the best interest of the company, so it is beneficial to have an agreement in place. If there is no agreement, the company should retain a lawyer to determine the best course of action and explain why exercising the repurchase right is the best decision.
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FAQs
A repurchase option is a term used when a company originally issues stock shares. It allows the company to repurchase the shares from the shareholders who own them at a later date. A repurchase option may be used for a number of reasons by a company.
What is the right of repurchase of stock options? ›
A share repurchase right in a financial contract gives the right holder the option, but not the obligation, to purchase (or repurchase) a predetermined number of shares at a predetermined price. Share purchase rights are typically offered to existing shareholders to boost management performance and the stock price.
What are the four main ways to implement stock repurchase? ›
There are four primary ways through which a company can repurchase its shares: (i) buying in the open market, (ii), buying back a fixed number of shares at a fixed price i.e. a fixed price tender offer, (iii) via a dutch auction, and (iv) repurchasing by direct negotiation.
What are the benefits of repurchasing shares? ›
With a buyback, the company can increase earnings per share, all else equal. The same earnings pie cut into fewer slices is worth a greater share of the earnings. By reducing share count, buybacks increase the stock's potential upside for shareholders who want to remain owners.
What is a repurchase agreement example? ›
Repurchase Agreement Example
Suppose a bank needs a quick cash injection. It agrees with an investor, who offers to give it the money it needs so long as it pays it back quickly with interest. In the meantime, the bank also provides collateral for peace of mind. At issue in the agreement are Treasury bonds.
How does buyback work? ›
A share buyback is when companies buy back their own shares from the market, cancel them and, ultimately, reduce share capital. With fewer shares in circulation, each shareholder gets both a larger stake in the company and a higher return on future dividends.
When should you repurchase shares? ›
A share repurchase or buyback is a decision by a company to buy back its own shares from the marketplace. A company might buy back its shares to boost the value of the stock and to improve the financial statements. Companies tend to repurchase shares when they have cash on hand and the stock market is on an upswing.
Is a stock repurchase program good or bad? ›
Who Benefits From a Stock Buyback? Companies benefit from a stock buyback because it can preserve stock prices, consolidate ownership, and take the place of dividends. Investors can benefit because they receive their capital back; however, a repurchase doesn't always benefit investors.
What are repurchase obligations? ›
The obligation to honor the "put" option and the obligation to provide cash to the ESOP when participants exercise diversification rights are usually referred to together as the ESOP "repurchase obligations."
How do you account for stock repurchase? ›
On the balance sheet, a share repurchase would reduce the company's cash holdings—and consequently its total asset base—by the amount of cash expended in the buyback. The buyback will simultaneously shrink shareholders' equity on the liabilities side by the same amount.
The journal entry is to debit treasury stock (an equity account) for the total cost of the shares repurchased. The credit is to cash for the amount paid. Treasury stock represents the company's own stock that it has reacquired and is available for reissuance or retirement.
What are common methods of repurchasing shares? ›
Methods of Stock Buybacks
- Open market stock buyback. A company buys back its shares directly from the market. ...
- Fixed-price tender offer. A company makes a tender offer to the shareholders to buy back the shares on a fixed date and at a fixed price. ...
- Dutch auction tender offer. ...
- Direct negotiation.
Buybacks can also backfire for a company competing in a high-growth industry because they may be read as an admission that the company has few important new opportunities on which to otherwise spend its money. In such cases, long-term investors will respond to a buyback announcement by selling the company's shares.
Are stock buybacks illegal? ›
For most of the 20th century, stock buybacks were deemed illegal because they were thought to be a form of stock market manipulation. But since 1982, when they were essentially legalized by the SEC, buybacks have become perhaps the most popular financial engineering tool in the C-Suite tool shed.
What is the main disadvantage of buying back shares? ›
Disadvantages of Share Buybacks
The primary reason for the ratio rise is the reduction of outstanding shares. It is not due to an increase in profitability. As a result, the share repurchase may present an inaccurate picture of a company's profitability.
Is repurchase the same as buyback? ›
Share buybacks signal confidence and optimize returns for shareholders. Repurchases enhance value by boosting stock prices and metrics. Drawbacks include timing concerns and potential metric manipulation.
