The Cashless Buyback^tm (patent pending) was devised circa 2005. It is an equity capital markets transaction and an example of a derivative security. Although a Cashless Buyback^tm is executed through issuance of an integral security that does not fall into the classification of commonly traded options, it nonetheless can be described in terms of a bundle of equivalent derivatives including various "exotic" options such as "knock-in" and "knock-out" options. The Cashless Buyback^tm transaction in fact was facilitated by the development of an increasingly robust derivatives market since the first, standardized public options were issued in the 1970's. The purpose of a Cashless Buyback^tm is to provide undervalued corporations a supplement or superior alternative to a cash buyback (sometimes referred to as a corporation's purchase of treasury stock). A related, predecessor transaction was the $30 million Ramtron Performance Rights offering executed by Lehman Brothers in 1994.

The Cashless Buyback^tm was developed as a response to the observation that cyclical, high growth companies such as semiconductor companies periodically experience disproportionate stock price declines. At times of undervaluation, it makes sense for a company to repurchase shares. However, in exactly those difficult times when share prices are undervalued, a cash buyback (a repurchase of outstanding common shares using corporate cash) might actually prove counterproductive: A consequent weakening of the balance sheet might cause an increase in the discount rate (the rate used to discount future cash flows in order to value the company), and the higher discount rate may more than fully offset any benefit to EPS (earnings per share) resulting from the reduction in outstanding shares.

A Cashless Buyback^tm addresses the discount rate problem in order to allow an undervalued corporation to repurchase its shares without changing its capital structure (the ratio of debt to equity; use of cash causes a deterioration in capital structure, all else equal). A company that undertakes a Cashless Buyback^tm incurs no debt, no interest charges, and no dilution. Cash only flows into the company, never out. In its simplest form, a Cashless Buyback^tm offers a corporation the following proposition:

"When your company's stock, now trading at $10 per share, hits a target of $16 anytime within the next 3 years, your company will then immediately sell a large block of stock at $30. Alternatively, if your company does not need the cash, then, upon hitting the target, it will receive back 20% of its outstanding shares at a cost of $0 (zero). If your company fails to hit the target, there is no penalty."

In addition to the unique features that make it economically attractive as a supplement or alternative to a traditional cash buyback, a Cashless Buyback^tm in its preferred implementation as a public exchange offer also provides transparency and fairness. These characteristics became of interest in 2006 due to the confluence of two events including 1) The growth of the cash buyback market, and 2) Governance scandals in the equity markets.

Cash buybacks through 2006 were typically executed as "open market" transactions under a United States Securities and Exchange Commission (SEC) rule 10b-18 exemption. While "10b-18 stock buybacks" were called "open market" transactions, they were anything but "open". Rather, 10b-18 cash buybacks were typically executed between limited groups of interested parties through privately negotiated transactions from which public investors were excluded. Because 10b-18 cash buybacks were shielded from scrutiny, they raised many questions regarding potential abuse: Is the price paid the true market price? Are all shareholders treated equally? Does management benefit by exercising options while the company is buying stock? Cash buybacks grew enormously during the 1990's and by mid 2006 reached an annual pace approaching $500 billion. An increasing proportion of company payouts were being made through cash buybacks rather than dividends, and the vast prepoderance of cash buybacks were "open market" buybacks. Because of the potential for abuse, the SEC mandated that, as of the beginning of 2005, all publicly listed companies must report monthly stock repurchase transactions. The rapid growth of the cash buyback market had clearly brought increased regulatory scrutiny.

A series of security scandals that erupted early in the 21st century brought additional controversy regarding the propriety of various equity market transactions. The mutual fund timing scandal of 2005, for instance, was a major event that helped lift Elliot Spitzer to the governship of New York (as New York District Attorney, he broke the case). Then, in 2006, options backdating (as reported by James Blander and Charles Forelle in the Wall Street Journal based on a study by University of Iowa academician Erik Lie) forced the resignation of many U.S. CEO's and further contributed to a crisis of confidence in the integrity of U.S. financial markets and corporate governance.

In brief, the combination of rapid growth of 10b-18 cash buybacks and various equity market scandals focused attention in 2005-2006 on whether corporate treasury operations (option exercises, stock transactions) were being executed in a fashion that respected the rights of public shareholders. The Cashless Buyback^tm, in addition to its economic attractions, responded to demands for improved transparency and equitable treatment of all shareholders.

For a compendium of works on the related subject of cash buybacks, see "Buybacks; A Minority View"by Gumport, listed 1/9/07 by SSRN ("Social Sciences Research Network") on its Top 10 Download Listfor Applied Corporate Finance and various related topics.