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What are shares and shareholders?
5 min read
What is the difference?
Although both methods are a way of rewarding shareholders, they can be significantly different in terms of what it means for the business and what it means for the individual shareholders.
With a dividend, shareholders are paid a monetary value per share, which is then taxed at that time. They could be looked upon as a solution for rewarding shareholders in the short term.
In the case of a share buyback, however, the business buys a number of shares back from the market, aimed at consequently increasing the value of the shares that are held. For the shareholders, any money that they make is only taxed when the shares are sold. Share buyback could be looked upon as a longer-term option than paying out dividends, as the cash stays within the company for more time.
How do share buybacks work?
The more shares that are out there, the lower the value of each share. The idea of a share buyback, therefore, is that the number of shares that are available reduces. This is made with the intention of increasing the value of each individual share so that when a shareholder sells their shares, they are worth more money.
Share buybacks are usually preferable for small and new businesses as paying out dividends can affect cash flow. Share buybacks are seen as a sign of confidence in the business but can also be risky as there is the chance that the value of the shares could go down.
What are the advantages of share buybacks?
There are a number of advantages for small businesses with share buybacks. Click on the dropdowns to read more.
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Rectifies the shares’ value
As outlined above, one of the main benefits to share buybacks is that they can be used to bring up the value of an individual share. For many businesses, this can be seen as rectifying the value of the shares to what they should be by reducing the number of shares that are available.
This can be a positive sign that the company is confident about the business and its future.
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Tax-effective rewards for shareholders
Shareholders that are paid in dividends will be taxed on the capital that they have gained on them at the time of being awarded them. This, however, is not the case with share buybacks. In the situation of share buybacks, the shareholders are not taxed until the shares are sold – according to the value of the share at that time.
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Cash stays within the business
When a business pays out dividends to its shareholders, they need to pay them with cash. This can have an effect on cash flow or money that could otherwise be reinvested into the company. This is why share buyback can be a good option, especially for small businesses that are looking to grow in size.
What are the disadvantages of share buybacks?
There are, of course, some disadvantages of share buybacks compared to paying dividends to shareholders for small businesses. Click on the dropdowns to read more.
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Uncertain returns
Although businesses can often help to increase the value of their shares, this is not necessarily always the case. A share buyback is a risk, and there is a chance that the value of the share can go down and shareholders not be rewarded at all.
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Lack of visibility
One of the main advantages of paying dividends is that the information about them is reported and available on corporate investor relations and financial websites. Share buyback details are difficult to find – although possible at times.
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Unrealistic values
Some people believe that share buybacks can actually give an unrealistic share value. This is because the price of the shares has not risen naturally, but, instead in a more contrived manner.
When might dividend not be the right option?
Dividends aren’t suitable in every situation.
They can only be paid if the company has sufficient distributable profits and can continue to meet its financial commitments. If profits are low or unpredictable, or the business needs to retain cash to fund growth or cover future costs, paying a dividend may not be appropriate.
Directors should also remember that dividends are not guaranteed. Unlike a salary, they can only be declared when the company’s financial position allows.
Before deciding how much to pay yourself, consider:
- the company’s profitability;
- its cash flow and future commitments;
- your own personal income needs; and
- the potential tax implications of different methods of taking income.
A combination of salary and dividends may be appropriate for some owner-managed companies, but the right approach will depend on your circumstances.
If you’re unsure, seek advice from a qualified accountant or tax adviser.
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