The “bare bones” explanation for why corporations issue stock is to raise capital for their businesses. Investors purchase shares of stock as a show of support that a business will continue to grow. When it does grow, investors and owners benefit. A corporate repurchase is a natural extension of stock fundraising. However, it is a far more complicated subject because there are so many terms competing for attention. Corporate repurchases, buybacks, repurchase agreements, repos, and reverse repos, all represent muddled and intermingled segments of similar processes. A corporate repurchase is also called a buyback; similarly, repurchase agreements, repos and reverse repos, which all define the same process, are often called buybacks.
In a lending buyback, also called a repurchase agreement, a corporation sells some or all of its securities, including stocks, bonds or money markets, at a premium rate. It agrees to repurchase those securities at a higher cost at some time in the future. In many ways, a corporate repurchase plan is like a secured loan, with the securities serving as collateral. The repayment of a repurchase agreement is usually within a few months. This is known as a short option loan. A long option loan is not as common. The repayment plan for these can extend to up to two years.
In a corporate buyback, a corporation systematically buys its own stocks back from stockholders or the general market. A corporation may use a repurchase agreement in conjunction with a corporate repurchase program in order to offset its cost; however, that is where the two ideas diverge.
A corporate repurchase program is a strategic method that can be construed to imply that a company believes that its stock is undervalued in the market. Offering a buyback plan allows corporate heads to purchase stocks from their stockholders, thus lowering the number of outstanding stocks. This actually drives the price of the stock up.
There are other reasons for corporate repurchasing as well. Some corporations might use a corporate buyback to increase internal control; others look at it as a way to offset the cost of offering compensation packages to their employees. When a company contributes to a 401K or offers stock options, this “dilutes” the company stock earnings, since they are effectively giving them away. A buyback brings those stocks back into a company’s control — and increases the stock‘s worth to remaining stockholders.
There are a couple of ways that a company may go about a corporate repurchase. One choice is to take the situation to the current stockholders by offering to purchase their stake in the company at a premium to the current market value of the stock. Investors usually have a short time to act on this offer. Another method that companies employ to repurchase their stock is by buying shares on the market over a longer period. In effect, a corporate repurchase allows a business to buy its company back from its stockholders. If a corporation succeeds in repurchasing 100% of its stock, it may leave the public trading circle all together and become a private corporation.