Definition
A share premium is the amount paid by an investor for a company’s share above its nominal value. It represents the additional amount over the face value that a buyer is willing to pay for the shares. The amount collected as share premium can be used by the company for various purposes as stipulated under the Companies Act.
Key Takeaways
- Share Premium refers to the amount that a company raises on selling its shares at a price higher than their face value. The difference between the sale price and face value is then transferred into a specific reserve known as the Share Premium Account which can’t be distributed as dividends.
- The use of Share Premium is governed by rules and regulations since it is not considered as profit. Typically, companies can use the share premium amounts for purposes like issuing bonus shares, writing off any loss or expense, or for the premium payable on the redemption of debentures or preference shares.
- Share Premium offers insight into a company’s financial health. If a company consistently sells shares at a premium, it suggests investor confidence and indicates that the company could be able to raise funds easily in the future if needed. However, it is also important to consider other factors and financial metrics when assessing the overall health and performance of a company.
Importance
Share premium is a fundamental financial term and an important aspect of a company’s financial structure.
It represents the additional amount over the face value that a company receives from the sale of its shares.
This extra income can significantly affect a company’s financial standing as it provides a valuable source of capital that can be used for various corporate purposes, such as funding new projects, settling outstanding liabilities, or retaining in reserves to boost the company’s financial base.
Furthermore, it serves as an indicator of the market’s perception of the company’s worth, evidenced by the willingness of investors to pay more than the nominal value for its shares.
Therefore, understanding share premium is vital in assessing a company’s monetary resources, potential for growth, and overall financial health.
Explanation
The term “Shares Premium” refers to the additional price that shareholders are willing to pay over and above the nominal value of shares. This parameter primarily rises from the buoyant demand for a company’s shares and is thus a reflection of the confidence investors have in the company’s future earnings potential.
It serves as an important financial tool that represents the perception of a company’s inherent value by the investing public. Shares premium is typically used for a number of essential corporate functions.
For instance, it can be used by companies to write off their preliminary expenses or to issue bonus shares to shareholders. Sometimes, a company might also use the share premium account to offset equity-related expenses, such as underwriting costs.
Therefore, the share premium presents an additional source of equity financing for firms, which can be a significant advantage in cases where a business needs to maintain a certain level of borrowing to meet other financial requirements.
Examples of Shares Premium
Share premiums are the additional amount over the nominal value that shareholders pay for new shares of a company’s common stock. Here are three real-world examples of share premiums:
Google: When Google opted for its Initial Public Offering (IPO) in 2004, the offering was extremely popular, and a large number of investors wanted to buy the shares, which led to a auction format for its IPO. The nominal value of Google’s shares might have been a certain amount, but the demand was so high that the shares were sold for a much higher price. This additional amount, over and above the face value, is termed as share premium.
Facebook Inc.: When Facebook went public in 2012, it started selling its shares at a price that was much higher than the face value of the shares. This was because of the high market demand and the expectation of high returns from the company’s common stock. As a result, the company generated a substantial amount of share premium.
Berkshire Hathaway Inc.: Berkshire Hathaway’s stocks are known for being some of the most expensive in the world, mostly because Warren Buffet decided to not split the company’s shares, causing their nominal value to grow over the years. The difference between the market price of the shares and their nominal value is one of the most striking examples of Share Premium. As of September 2021, a class A share of Berkshire Hathaway was trading over $400,
Frequently Asked Questions about Shares Premium
What is Share Premium?
A share premium, also known as securities premium, is the amount by which the price at which shares are issued is more than their nominal value. It’s typically earned by the company when its shares are issued at a premium, usually in an initial public offering (IPO).
How is Share Premium calculated?
Share premium is calculated by subtracting the nominal value of a share from its issue price. If the share is issued at a price higher than its nominal value, the excess amount is the share premium.
Why do companies have a Share Premium?
Companies with a share premium account can use it for a variety of reasons like writing off its preliminary expenses, issuing bonus shares to existing shareholders, writing off the costs or commissions paid on issue of shares, etc.
Is Share Premium considered as capital?
Share premium can be considered as a part of a company’s equity capital. It is included in the shareholders’ equity section of the balance sheet. However, it is not part of the share capital and does not carry any voting rights.
How does Share Premium affect the Balance Sheet?
A share premium increases the equity of a company and can be used to provide for future losses. It appears in the shareholders’ equity section of the balance sheet. The result is a boost in the company’s net asset value.
Related Entrepreneurship Terms
- Equity Capital
- Capital Reserve
- Shareholder Equity
- Par Value
- Issued Shares
Sources for More Information
- Investopedia: A comprehensive investment and financial education website covering a wide range of topics including detailed explanations on share premium.
- Accounting Tools: A website that provides a wide range of free resources, including articles, courses, and webinars related to accounting and finance concepts, including shares premium.
- Corporate Finance Institute: A professional training and certification provider in finance, which provides detailed resources and tutorials on various finance topics such as shares premium.
- Financial Express: An Indian business news website that provides news, analysis, and detailed articles on global and regional financial updates, including topics about shares premium.
