Share premium

What Is Share Premium?

Share premium, also known as additional paid-in capital or contributed capital in excess of par, is the amount of money a company receives from issuing its share capital that is above the shares' stated par value. It is a component of a company's equity on its balance sheet and falls under the broader financial category of Corporate Finance. When a company sells its common stock or preferred stock at a price higher than its nominal or par value, the excess amount is recorded as share premium. This premium represents an additional capital contribution from investors beyond the legal minimum required for the shares.

History and Origin

The concept of share premium is intrinsically linked to the historical development of par value in corporate law. In the 19th century, par value was introduced as a legal minimum price for shares, primarily to protect creditors. It was intended to ensure that a company maintained a certain level of capital against which it could borrow. Early corporate laws assumed that shares would be issued at this par value, and issuing shares below par was often prohibited to prevent the "watering" down of capital, which could mislead investors and creditors.⁵

As financial markets matured and the market value of shares began to significantly diverge from their often arbitrarily low par values, companies frequently issued shares at prices well above par. The difference between the issuance price and the par value became what is now known as share premium. This practice allowed companies to raise substantial capitalization without increasing their legal share capital beyond a nominal amount, thereby providing flexibility in issuance.⁴ The initial protection mechanism evolved, leading to the establishment of separate accounting treatments for the par value and the premium received.

Key Takeaways

• Share premium represents the excess amount received when shares are issued above their nominal or par value.
• It is recorded as a distinct component of shareholders' equity on a company's balance sheet.
• The funds in the share premium account are generally considered non-distributable reserves, meaning they cannot typically be used for paying ordinary dividends.
• Common uses for share premium include offsetting share issuance costs or funding bonus share issues.
• The concept highlights the difference between a share's legal minimum value (par value) and its actual market-determined value at the time of sale.

Formula and Calculation

The calculation of share premium is straightforward: it is the difference between the actual issue price of a share and its par value, multiplied by the number of shares issued.

Where:

• Issue Price Per Share: The price at which the company sells its shares to the public or private investors.
• Par Value Per Share: The nominal or stated value assigned to each share, as defined in the company's articles of incorporation. This is often a very low, symbolic amount (e.g., ( $0.01 )).
• Number of Shares Issued: The total count of new shares sold by the company.

This formula demonstrates how the actual capital raised goes beyond the nominal share capital recorded at par value.

Interpreting the Share Premium

Share premium reflects the market's perception of a company's value beyond its basic legal capital. A substantial share premium account indicates that investors are willing to pay significantly more than the minimum legal value for the company's shares, often due to strong financial performance, growth prospects, or market demand. It is a testament to the company's ability to attract investment at favorable terms.

From an accounting perspective, share premium is a non-distributable reserve, meaning it cannot be used for general purposes like paying cash dividends or covering operational losses. Its specific uses are often restricted by corporate law and accounting standards. It is presented in the equity section of the balance sheet as "Additional Paid-in Capital" or "Share Premium Account," providing transparency on how the company's equity was generated.

Hypothetical Example

Consider XYZ Corp., a newly established company planning an Initial Public Offering (IPO). The company's charter states that its common shares have a par value of ( $0.01 ) per share. Due to strong market interest and positive analyst forecasts, XYZ Corp. successfully issues 1,000,000 common stock shares to investors at an issuance price of ( $25.00 ) per share.

To calculate the share premium:

1. Determine the excess per share:
   ( $25.00 ) (Issue Price) - ( $0.01 ) (Par Value) = ( $24.99 ) per share

2. Calculate total share premium:
   ( $24.99 ) per share * 1,000,000 shares = ( $24,990,000 )

On XYZ Corp.'s balance sheet, the share capital related to the par value would be ( $10,000 ) (1,000,000 shares * ( $0.01 )), while the share premium account would reflect ( $24,990,000 ). The total contributed capital from this share issuance would be ( $25,000,000 ).

Practical Applications

Share premium appears in several key areas of Corporate Finance and financial reporting:

• Public Offerings and Equity Financing: During an Initial Public Offering or a secondary offering, the share premium accounts for the vast majority of the funds raised, especially for established companies with a low par value. This allows companies to raise significant capital from the market.
• Balance Sheet Presentation: Under both U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), share premium is reported separately within the equity section of the balance sheet. For instance, IAS 1, which governs the presentation of financial statements, requires disclosures relating to issued share capital and reserves, which includes share premium.³
• Statutory Capital Requirements: In many jurisdictions, share premium contributes to a company's legal capital, which can have implications for insolvency and creditor protection. Regulators like the SEC.gov mandate detailed financial reporting for publicly traded companies, ensuring transparency in how capital is raised and accounted for.²
• Share Issuance Costs: Companies can legally use the share premium account to absorb certain expenses related to the issuance of new shares, such as underwriting fees, legal costs, and administrative charges, rather than expensing them through the income statement.

Limitations and Criticisms

While share premium is a standard accounting concept, its underlying component, par value, has faced considerable criticism for its diminishing relevance in modern corporate finance. Many financial experts argue that par value is largely an archaic concept with little practical meaning for investors, as it is often set at a nominal amount (e.g., ( $0.0001 )) that bears no relation to the share's market value.¹ This makes the distinction between par value and share premium seem less intuitive to those outside of accounting and legal fields.

Furthermore, the statutory restrictions on the use of share premium can sometimes limit a company's financial flexibility. While it prevents the misuse of capital raised from share sales, it means these funds cannot be freely used for purposes like paying regular cash dividends to shareholders or covering operational deficits. Companies must maintain careful records to differentiate between retained earnings (which are distributable) and share premium (which typically is not). This can sometimes lead to confusion regarding a company's overall equity and the sources of its financial strength.

Share Premium vs. Paid-in Capital in Excess of Par

The terms "share premium" and "Paid-in capital in excess of par" refer to the same accounting concept and are often used interchangeably. Both terms describe the additional amount of capital that a company receives from investors when it issues shares at a price higher than their nominal or par value. The difference is primarily one of terminology, with "share premium" being more commonly used in IFRS (International Financial Reporting Standards) jurisdictions, while "Paid-in capital in excess of par" is the preferred term under U.S. GAAP (Generally Accepted Accounting Principles). Regardless of the nomenclature, both represent the same fundamental increase in a company's equity that arises from selling shares above their minimum legal value.

FAQs

What is the primary purpose of share premium?

The primary purpose of share premium is to record the amount of money a company receives from selling its shares that is above their nominal or par value. It reflects the additional capital contributed by investors beyond the minimum legal requirement.

Can share premium be used to pay dividends?

Generally, no. Funds classified as share premium are typically considered "non-distributable reserves" under corporate law and accounting standards. This means they cannot be used to pay regular cash dividends to shareholders. Their usage is restricted, often to specific purposes like absorbing share issuance costs or funding bonus share issues.

How does share premium affect a company's balance sheet?

Share premium is presented as a separate component within the equity section of a company's balance sheet. It increases the total shareholders' equity, signifying the capital raised from share sales beyond the par value. This separation provides a clearer picture of the sources of a company's capital.

Why do companies issue shares at a premium?

Companies issue shares at a premium to reflect their true market value, which is usually significantly higher than the nominal par value. Issuing shares at a premium allows companies to raise more capital from investors without needing to issue a larger number of shares, thereby avoiding excessive dilution of existing shareholders' ownership. It's a common practice in successful equity fundraising.