When a company wants to raise money, they often sell a portion of their ownership. For private companies, this means selling a percentage of their company to venture capitalists and private investors in exchange for a giant chunk of change. When a company goes public and files an initial public offering (or IPO), they sell shares of stock in their company to public investors like you. These shares give you and every other investor an infinitesimally small ownership in exchange for money.
Yet what happens when a company has more money than they know what to do with?
The magic of share buybacks.
When a company exists for enough time and raised more money than they need, they often buy those shares back. After hearing votes from their board of directors and their shareholders, a company whose stock you hold can offer to give you money in exchange for your shares. When a company buys back shares, they often do so at a premium, or higher than the current share price.
This might sound exciting to you, since it could potentially mean an automatic profit. Yet share buybacks aren’t without their risks and traps. To explain how buybacks work and what they mean for you, the investor, the Financial Times put together this painfully awkward video on the subject. Even if you’re just investing in ETFs, learning about buybacks now could save you from a financial headache in the future.
Buybacks are one way to spend money. Companies could also pay dividends, make acquisitions, and even pay off debt. By buying back shares, public companies essentially consolidate their power a bit more. Buybacks could also make the rest of the existing shares more valuable, as demand will stay the same or increase, but supply will decrease. Whether you accept a buyback is up to you, but if you’re investing for the long-term, you’re going to want to hold onto those sweet, sweet shares for as long as possible.