What is 'Capital Reduction'

Capital reduction is the process of decreasing a company's shareholder equity through share cancellations and share repurchases, also known as share buybacks. The reduction of capital is done by companies for numerous reasons, including increasing shareholder value and producing a more efficient capital structure. After a capital reduction, the number of shares in the company will decrease by the reduction amount. While the company's market capitalization will not change as a result of such a move, the float, or number of shares outstanding and available to trade, will be reduced.

The act of capital reduction may also be enacted in response to a decline in a company's operating profits or a revenue loss that cannot be recovered from a company's expected future earnings. In some capital reductions, shareholders will receive a cash payment for shares canceled, but in most other situations, there is minimal impact on shareholders.

BREAKING DOWN 'Capital Reduction'

Specific Examples of Capital Reduction

Many companies decide to reduce capital through repurchase agreements (buybacks) or share cancellations. For example, AS Tallink Grupp, an Estonian shipping company that operates in the Baltic Sea and provides high-quality mini-cruises to its customers, reported that it would reduce its shares on June 14, 2016. The company decided that it would move forward with a reduction of the book value of its shares, where the €40 million in cash generated from the share cancellation was to be paid out to the company's shareholders by December of that year.

A company is required to reduce its share capital using a set of specific steps. First, a notice must be sent out to creditors of the resolution of the capital reduction. Second, the company has to then submit an application for entry of the reduction of share capital no earlier than three months after publication of the initial notice. Share capital reduction is then expected to be paid to shareholders no earlier than three months after the entry of reduction in the commercial register.

Using another example, StarDSL AG, a German-based company that provides satellite telecommunications services and products in the field of data and voice services, announced a capital reduction on July 21, 2016. The capital reduction was to be performed through a reverse stock split with a 10:1 ratio. After the company consolidated its shares, capital was reduced by about €11.3 million.

Finally, GAM Holding AG, an independent, pure play asset management group based in Switzerland, reduced its capital on April 27, 2016. The capital reduction was carried out through a share buyback program, and the company eventually canceled 3,100,000 repurchased shares because adequate reductions in capital had already been made. The share capital as of July 13, 2016, was equal to 8 million Swiss francs.

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