Stock buyback question?

Buying back stock is NOT an expense, just as purchases of other companies' stocks are not expenses, although there are significant differences in effects and accounting for the company. Companies repurchase their own stock for a variety of reasons including as a means of returning cash to stockholders without increasing the dividend. Such a move is often related to a company having "excess" cash, and by "excess" I mean they do not have other investment (including positive NPV projects) opportunities. These days, many companies are sitting on mounds of cash. They are not returning it to shareholders in the form of dividends or stock repurchases...essentially, they are waiting...generally waiting for the right economic and regulatory climate to invest in and expand their businesses. This cash, whether it sits there as cash or is returned (paid) to shareholders through stock repurchases is from retained earnings - so it is post-tax earnings. A company COULD buy back stock with debt proceeds, which changes their capital structure (as does simply buying back stock from retained earnings). The interest on the debt is tax deductible (an expense) but the principal amount, when repaid, is not. Debt, like equity, is a form of capital, and when it is "returned", i.e. for equity - a stock repurchase, for debt - repayment of principal, it is not an expense.

Consider the following, from:

http://www.investopedia.com/exam-guide/cfa-level-1...

A stock repurchase occurs when a company asks stockholders to tender their shares for repurchase by the company. This is an alternate way for a company to increase value for stockholders. First, a repurchase can be used to restructure the company's capital structure without increasing the company's debt load. Additionally, rather than a company changing its dividend policy, it can offer value to its stockholders through stock repurchases, keeping in mind that capital gains taxes are lower than taxes on dividends.

Many companies initiate a share repurchase at a price level that management deems a good entry point. This point tends to be when the stock is estimated to be undervalued. If a company knows its business and relative stock price well, would it purchase its stock price at a high level? The answer is no, leading investors to believe the management perceives its stock price to be at a low level.

-Unlike a cash dividend, a stock repurchase gives the decision to the investor. A stockholder can choose to tender his shares for repurchase, accept the payment and pay the taxes. With a cash dividend, a stockholder has no choice but to accept the dividend and pay the taxes.

See the above link for more info...

[Note: Although the above refers to publicly traded companies, the same accounting treatment (re: repurchase NOT being an expense, holds true for private companies. Depending on the reason they want to buy out the investor, the cash used to buy back the stock could be from retained earnings or the company may (if they can) borrow to buy out the investor. Keep in mind that borrowing costs (cost of debt) are typically lower than the cost of equity, and interest on that debt is tax deductible (an expense) but the principal amount of the debt (a form of capital) is not.]

It could be bought by the other shareholders or a new investor. Otherwise it would be bought with pre-tax funds (profit or reserves). I think.