A Complete Guide to Share Premium Account

Ryan Patrick

Mar 22, 2024 • 6 min read

In the market, companies sometimes want to increase their market value and thus tend to increase the price of their shares. The high prices of these shares tend to increase the valuability of the company to the public and specifically investors who would want to invest in a company.

Although a company can increase its market value in many ways, increasing the number of its shares is one of the most valuable ways of increasing the market value of a company and attracting potential investors and clients.

A share premium is the income earned by a company from increasing the amount of its shares above the normal amount. The normal amount paid for a share is also called a nominal value.

To understand share premium, you have to understand the meaning of nominal value. Nominal value is the basic amount paid for shares of a company. The nominal value for shares is £1, a company can increase this amount and sell the shares of your company for any amount.

For instance, a company can sell their shares for £10 instead of the £1 nominal value for shares, therefore, if a company sells off 10 shares to an individual, that will be £100.

The share amount minus the nominal value (£10-£1) equals the premium shares amount paid by that individual.

Shares Capital

When a company is incorporated, the company must issue shares at a nominal value. The value generated from issuing shares at nominal value is referred to as the share capital of a company. It is sometimes called the aggregate nominal capital.

If a company issues 200 shares at a nominal value of £1, then the share capital is all the nominal values of the 200 shares added together. In this case, the share capital will be £200.

The value of a company's share capital does not determine the value of the company as a whole. You'll have to relate it to the current market value of each of the company's shares, which is always higher than the nominal value.

The difference between the market value of a share and the nominal value is referred to as the share premium.

Read this blog here to learn more about share capital in the UK.

According to the Companies Act 2006, all premiums of shares should be sent to a separate account which is called the "share premium account". The premiums in no condition, should be transferred to the company's actual share capital account.

Even if the name says otherwise, a share premium account is not a separate bank on its own but is typically an accounting entry. Under the balance sheet spreadsheet of a company, the shed premium is typically listed under the capital and reserves section.

Although the funds in a share premium account belong to the company, they cannot be distributed. It is a non-distributable reserve that cannot be treated as a company's profit. The funds in a company's share premium account cannot be used to pay dividends to company shareholders.

The share premium can only be used for special transactions including expenses that are related to the issuance of the premium shares like underwriting costs, and also it can be used to issue fully paid bonus shares to already existing shareholders.

Reasons Why Companies Issue Premium Shares

After selling shares at nominal values, a company can issue shares at a premium value. Before issuing shares at a premium value, the company must first make sure that the premium price of the shares reflects the market value of the shares.

Mostly, the market value of shares is much higher than the nominal value so selling new company shares at a premium value tries to create a fairness network between old shareholders and new shareholders.

Issuing shares at a nominal value to new shareholders will not be fair as the market value of the shares has increased and old shareholders since the creation of the company cannot buy shares of the same value as new shareholders.

Most times, companies sell shares at a premium value to fund the issuance of bonus shares to their existing members on a pro-rata basis. That is the shares are of the same proportion as the current percentage of shareholdings.

The company issues these fully funded bonus shares to their members including employees, secretaries, directors or existing shareholders instead of paying them dividends for the shares. This helps the company to maintain its profits and at the same time reward the members of the company.

Private limited companies also give out bonus shares to their members to increase their issued share capital to £50,000 to be able to re-register as a public limited company. Once a private company's share capital surpasses £50,000, a company can then register as a public limited company (PLC).

Share premium is a great way of increasing company market value. Here are the advantages of a premium share.

1. Increasing Company Value

Increasing the share capital of a company can increase the value of the company to the public. Most creditors check the value of the company before agreeing to give out loans or debts to those companies. Some organisations also check out the membership numbers as well as the number of shares sold out before agreeing to give out loans or debts to help the company.

If a company has a high market value it will enable them to attract creditors who are willing to give out loans and debts to companies.

2. Attracting Investors

If a company has a large share capital, the company will appear more financially secure and stable to investors and thus they will want to invest in the company. Investors will want to invest in a company that has a large paid up share capital and a higher market value.

The appearance of a company to the public will influence how investors troop in the company and invest in it.

3. Serves as Loans

Companies can take out their share capital as loans instead of taking loans from the bank. The bank comes with various and sometimes complicated conditions for loans and sometimes the process is very tiring. To save the company the stress of going through the process of obtaining a loan, the company can choose to take out their share capital instead.

Also, unlike bank loans, share capital will not need interest when paid back by the company. In this way, if the company has an urgent need for funds, it can turn to the share capital rather than going to the bank for a loan.

Though share premium is a great way of increasing company market value, even as great as it is, it still has some disadvantages. Here are the disadvantages of a share premium.

1. Dilution of Power

Increasing the value of the shares of a company can in some ways dilute the power of already existing shareholders or founders of the company. Since the new shareholders are buying the shares for a much higher price than the existing shareholders, a new shareholder who buys more shares can have as much power as an already existing shareholder.

2. Control by Newer Shareholders

If a new shareholder purchases a very high-value share and becomes a person with significant value of the company, then the new shareholder can have control over the company more than previous shareholders.

As from what has been explained above, we have to say that since the advantages of share premium outweigh the disadvantages, then share premium is a very good strategy for increasing company market value, attracting investors and also helping the company when in need of funds.

Share premiums are not only limited to growing or small companies but can also be done by very large companies to keep a balance between their expenses and income.

Conclusion

Share premium as said above, is the difference between the share amount and the nominal value value. The nominal value for shares is £1 and companies can increase them to a higher amount. Companies can increase their shares amount to increase their share capital. Increasing the share capital of a business does a very good job of boosting the productivity and market value of the company to creditors, investors, potential shareholders and even clients or customers.

Companies with greater value can also increase their shares from nominal to premium to be able to exceed the threshold of £50,000 for private limited companies and be able to qualify for registration as a public limited company (PLC). Do you have any questions about share premium? If so, kindly contact one of our experts for help today.

What is Share Premium