What happens when a company buys its own shares?


Why does this reduce capital, and why does this reduce the company’s ability to pay creditors?

In: 141

Because they’ve spent money. Capital is money. If you spend money to buy something you have less money and therefore less capital. If you have less money then that reduces your ability to pay other people, like creditors.

Let’s say I want to sell shares in a farm (the whole 100% to keep it simple). I can decide how many shares to sell, or how many pieces the ownership will be divided into.

I could divide it into 2 shares, and give my wife one. Or I could divide it into 6 shares, keep 1, give 1 to my wife, and 1 to each of the 4 kids. As the owner you decide (basically) on how much shares to offer.

Say I decide to offer 200 shares for sale that would effectively mean each share get the profit from half arce of land. So people give money to the company and receive a share of the profit.

Let’s say the farm does well and we have huge profits, the owners can decide to buy back the shares in this example they buy back 100 shares. This means they do the opposite of the initial offer, they give money to people (shareholders) and get the shares back. So less shares are now on the market, now the total shares are 100 and each share is of a full acre.


Share buy back is effectivly the opposite of an initial public offering.

Do purchased shares get dissolved, or does the company actually own itself and experience gains and loses on that value?

Imagine a million people each own 1 share. The company makes a million in profit this yeah so each share holder gets a dollar. Then the company buys back 500,000 shares. Next year the company also makes a million in profit but since there are only 500,000 shares outstanding each shareholder gets 2 dollars.

There’s a company worth $50, that has 10 shares each worth $5. The company ends the year with $10 in profit, so instead of giving that $10 to the shareholders as dividends (which are taxed as income), they spend that money to buy 2 of the shares. Now there are 8 outstanding shares but the company is still worth $50, so each share is worth $6.25, and the remaining shareholders have the choice of when to sell their shares and realize their gains (which are taxed as capital gains, which can often be lower).

TLDR: Like 90% of finance and accounting, its about paying less taxes.