Share premium

3 key takeaways

• Share premium represents the excess amount received over the nominal value of shares issued by a company.
• This premium is recorded in a separate account called the share premium account, which is part of the company’s equity.
• Share premium funds can be used for specific purposes such as writing off preliminary expenses, issuing bonus shares, and buying back shares.

What is share premium?

Share premium, also known as additional paid-in capital, is the amount of money a company receives from shareholders when issuing shares that is above the nominal or par value of the shares.

For example, if a company issues shares with a nominal value of $1 per share but sells them for $5 each, the share premium is $4 per share. This excess amount is recorded in the company’s share premium account, which is a part of shareholders’ equity on the balance sheet.

The share premium account is used to reflect the additional capital that shareholders are willing to invest in the company above the nominal value of the shares, indicating investor confidence and the perceived value of the company’s stock.

Uses of share premium

Funds in the share premium account can be used for specific purposes as outlined by corporate law and the company’s articles of association. Common uses include:

• Writing off preliminary expenses: Share premium funds can be used to write off the costs associated with the formation of the company, such as legal fees, registration fees, and other startup expenses.
• Issuing bonus shares: Companies can use share premium to issue bonus shares to existing shareholders, effectively converting the premium into share capital and distributing it proportionally among shareholders.
• Buyback of shares: Share premium can be used to buy back the company’s shares from the market, reducing the number of outstanding shares and potentially increasing the value of remaining shares.
• Capital restructuring: Funds from the share premium account can be used for restructuring the company’s capital, such as reducing debt or funding mergers and acquisitions.

These uses provide flexibility for the company to manage its finances and capital structure effectively.

Accounting for share premium

The share premium account is a crucial component of shareholders’ equity and is reported separately from other equity components. The accounting entries for share premium typically involve:

• Initial issuance: When shares are issued at a premium, the amount received is split between the nominal value and the share premium. For example, issuing 1,000 shares with a nominal value of $1 each at $5 per share would result in a $1,000 credit to share capital and a $4,000 credit to the share premium account.
• Utilization: When share premium funds are used for permitted purposes, the share premium account is debited accordingly. For instance, if $1,000 from the share premium account is used to write off preliminary expenses, the account is debited by $1,000.

These entries ensure accurate tracking and utilization of the share premium funds.

Legal and regulatory considerations

The use of share premium funds is governed by corporate laws and regulations, which vary by jurisdiction. Key considerations include:

• Restrictions: Laws often restrict the use of share premium funds to specific purposes, preventing their use for general operating expenses or dividend payments.
• Disclosure: Companies must provide clear disclosures about the share premium account and its uses in their financial statements, ensuring transparency for shareholders and regulators.
• Approval: Certain uses of share premium funds, such as issuing bonus shares or share buybacks, may require approval from the board of directors or shareholders.

Adhering to these legal and regulatory requirements is essential for maintaining compliance and protecting shareholder interests.

Examples and case studies

Examples of share premium in practice include:

• IPO and secondary offerings: During an initial public offering (IPO) or secondary offering, companies often issue shares at a premium, resulting in significant share premium amounts. For example, if a company issues 1 million shares with a nominal value of $1 at $10 per share during an IPO, the share premium would be $9 million.
• Bonus share issuance: A company with a substantial share premium account may decide to issue bonus shares to existing shareholders. For instance, if a company issues 100,000 bonus shares using $500,000 from the share premium account, the premium is converted into share capital without requiring additional investment from shareholders.
• Share buyback: A company may use share premium funds to repurchase its shares from the market. For example, if a company buys back 50,000 shares at $20 each using funds from the share premium account, it reduces the number of outstanding shares and potentially enhances shareholder value.

These examples illustrate the practical applications and strategic uses of share premium in corporate finance.

Share premium is an essential component of a company’s equity, reflecting the additional capital investors are willing to pay above the nominal value of shares. By understanding its uses, accounting treatment, and regulatory considerations, companies can effectively manage their share premium funds to support growth, restructuring, and shareholder value creation.