Indiamart is overpaying to buy its own stock

Or how a little creativity can help a company's founders make more money

Indiamart’s founders after some nifty financial engineering

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If you’re the founder of a company, there are a few ways you can get some money out from the company’s bank account into your own bank account.

You can draw a higher salary or bonus. You’re presumably still an employee; CEO, director, chairman, whatever. So you can just pay yourself a higher salary. The problem with this is that you’d then also be taxed like an employee. 30–40% of whatever you pay would go to the government as tax.¹

But as a founder, you’re not just an employee, but also likely a large shareholder. If a company wants to pay its shareholders, it can either (1) issue a dividend, or (2) buy back stock. Dividend is taxed just like salary, so that’s out. But option (2) is interesting. You’re selling stock in a buyback! You pay no tax.²

Now if a company wants to run a stock buyback, it must also decide at what price it wants to buy this stock. The usual figure is around 10–15% more than the market price of the stock. Sometimes a bit more if the company’s had a great year and is feeling generous. But it’s in the same ballpark.

The company is buying stock, so its goal—like any buyer—is to buy at a price that’s as low as possible, but still high enough for investors to want to sell their stock to the company in the first place. The lower the price at which the company buys back its stock, the more stock it can buy, and the more valuable the remaining shares become for the shareholders that don’t sell. But if you’re the founder and your plan is to sell stock in the buyback, you want your company to pay as much as possible for your stock.

Last week, ecommerce company Indiamart announced a stock buyback. The company will be buying back stock worth ₹500 crore ($62 million) at ₹4,000 ($48) per share. This is 37% more than its around ₹2,900 ($35) share price at the time of announcement. Indiamart also disclosed that its founders might be selling some stock in this buyback.

Well, of course! The only reason for a company to price its buyback almost 40% more than market price is so that its founders can get a good price for their shares.

Been there, done that

If a company decides to buy back its stock at 40% over market price, the natural thing for investors to do is want to sell their stock to the company. But of course, the company can’t buy back all the stock. This is how it goes:

1. Company decides to buy back a fixed number of shares (at a fixed price).³

2. People apply to sell their shares.

3. If people have applied to sell more stock than the company plans to buy, it has to buy shares from each shareholder proportionate to the total shares they own.⁴

Since Indiamart is going to overpay for its stock, there’s no doubt that there will be an overabundance of investors willing to sell. It’s the rational thing to do. Eventually, they’ll only be able to sell a fixed percentage of the total stock they offer to sell. Whoever owns the most can sell the most.

Indiamart’s founders—Dinesh Agarwal and Brijesh Agrawal—along with others from the Agarwal and Agrawal families, own about 49.22% of Indiamart’s stock. The largest chunk! Indiamart has said that it will buy back 12,50,000 shares. Now, SEBI mandates that 15% of any buyback be reserved for small retail investors who don’t own too much stock (oh cute Robin Hood you, SEBI). That leaves 10,62,500 shares for everyone else. Assuming the founders go for goal here, they’ll sell at least 48.22% of the 10,62,500 shares which Indiamart ends up buying.

This isn’t even the first time Agarwal and Agrawal are using the buyback route to make some money. They did exactly this last year, just with a smaller amount of money. This year Indiamart’s buying ₹500 crore of stock, last year it had bought ₹100 crore, at a similar 36–37% markup over market price. Of this ₹100 crore, 42.12% went to Agarwal and Agrawal. Or 49.56% of ₹85 crore if you disregard the 15% reserved for small investors.⁵

See, there’s nothing particularly wrong with what Agarwal and Agrawal are doing. There’s no upper limit to the price at which a company can buy back its stock. Though I wonder what would happen if Indiamart took this into bizarre territory. What if, instead of a puny 40% premium over market price, the company decided to buy stock at.. ₹500 crore per share? If this were to happen—and I don’t see why it couldn’t if everyone at the board meeting managed to keep a straight face and approve it—investors would apply to sell their stock and Indiamart would say “hmmm everyone wants to sell their shares but oh no we can only afford to buy 1 share because it’s so expensive.” And of course that 1 share would be the founders’ share because they own the largest chunk of stock. I mean, sure, SEBI would probably not let this through, but I promise you they’d struggle to find an actual rule to cite while saying no.

Correction: I’d mentioned that the founders would have to pay a 10% tax if they sold in the buyback. Turns out this changed in 2019 and the seller doesn’t pay tax (the company does in their place). Corrected this in the post.

1. Salaries are expenses, and expenses are super tax efficient for the company. More expenses mean less profit. Less profit equals less tax.

2. The company does pay a ~20% buyback tax, so the government gets about the same money no matter what.

3. The share price or even the number of shares isn’t always fixed. I wrote late last year about Paytm’s buyback where it had only decided a maximum price and was buying stock from the market directly. SEBI doesn’t like this type of buyback though and is phasing it out.

4. For instance, let’s say a company wants to buy 100 shares and receives two bids both greater than 100. The first shareholder owns 1000 shares, the second investor owns 500 shares. Which means the company has to buy 6.66% of their combined total shares (100 out of 1500). So the company will buy 66 shares from the first shareholder (6.66% of 1000) and 33 shares from the second shareholder (6.66% of 500). The buyback process gives a higher preference to larger shareholders.

5. Thanks to Chandragupta over at ValuePickr for helping me figure this calculation.