MBA in 2 minutes | Lesson 15 : How to account for share buybacks
Updated: Jan 8, 2021
We will be solving practical challenges through MBA concepts. No theory only applications !
In this blog, we will discuss finance and accounting together. You may be working in sales/marketing teams , but you should be aware why founders of your organisations are buying back their shares.
I will run this lesson in case method. In an unprecedented move, India's unicorn- Oyo's- CEO,Ritesh Aggarwal bought back his shares from initial round investors-Sequoia and Lightspeed .
We will discuss why sharebuy backs are needed and what goes in the accounting statements during the transaction to understand business implications.
Step 2: Why do founders/organisations buy back shares
1. To increase valuations and retain higher control. This is why I believe Ritesh primarily took this bold step. A buyback will increase share prices. A reduction in the number of outstanding shares often precipitates to a price per stock increase because of economics of supply & demand.
With this move, Oyo has a valuation of whooping USD 10B and a valuation multiple of 50X ( more on valuations in coming lessons).
Interestingly, Zuckerberg also holds higher shares in Facebook to not let go of decision power . ( As an entrepreneur myself, I am completely in sync with majority share holding by founders).
Now lets also look at why organisations in general buy back shares (including but not limited to) -
2. To reissue shares to officers and employees under bonus and stock compensation plans
3. To increase trading of the company’s stock in the securities market.
4. To have additional shares available for use in acquiring other companies.
5. To increase earnings per share.
6. To eliminate hostile shareholders.
7. To retire the stock
Step 3: Accounting statements implications
There will be 2 parallel entries for share buys-
Credit entry of Cash ( on assets side of balance sheet)
Debit entry of treasury stock (on equity side of balance sheet)
The Treasury stock is a contra-equity account shown as reduction from shareholders’ equity. It is NOT recorded as an asset on the balance sheet because it does not makes sense to say that a company owns a part of itself.
With this lesson, you will be able to not only hold conversations but also drive the math when other potential unicorn founders such as Urban Company buy back shares.
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