What it means
When a company is first set up, each share is given a nominal or par value, which is usually a very small amount like one penny. However, as the business grows and becomes more valuable, new investors are willing to pay much more than this nominal value for each share.
The total amount raised is split into two parts. The nominal value goes into the share capital account, and the leftover amount goes into the share premium account.
This separation is a legal requirement designed to protect creditors by ensuring a core baseline of capital remains locked inside the business. For non-finance managers, understanding share premium helps clarify how equity funding actually hits the balance sheet.
It is important to note that share premium is not profit. You cannot use it to pay staff bonuses or shareholder dividends because it represents capital contributed by owners, not money earned from trading operations.
Instead, companies typically use share premium reserves to write off preliminary expenses, cover the costs of issuing the shares, or issue bonus shares to existing investors later on. In practical terms, a large share premium account shows that the market has high confidence in the company, allowing it to raise substantial funds without giving away an excessive number of ownership shares.
It represents the goodwill and future potential that investors see in the enterprise, quantified in hard cash.
In practice
Real-world examples.
Example
TechStart issues 10,000 new shares with a nominal value of GBP 1 each, but investors pay GBP 15 per share. The GBP 140,000 difference goes straight into the share premium account.
Example
Baker & Sons bakery issues 5,000 shares with a nominal value of GBP 10 at an issue price of GBP 50. This generates GBP 200,000 in share premium to fund a new commercial oven.
Example
GreenEnergy Ltd issues 50,000 shares with a nominal value of GBP 0.10 for GBP 5 each. The resulting share premium of GBP 245,000 strengthens the balance sheet for a major expansion.
Think of it
“Imagine buying a branded cinema ticket printed with a face value of GBP 1, but because the film is so popular, you gladly pay GBP 15. The cinema keeps the extra GBP 14 in a special fund for upgrading the theatre, rather than spending it on daily snacks.
Formula
Calculation
Share Premium = (Issue Price per Share - Nominal Value per Share) x Number of Shares Issued.
Example: A company issues 1,000 shares. The nominal value is GBP 1, but investors pay GBP 20.
Issue Price (GBP 20) - Nominal Value (GBP 1) = GBP 19 premium per share.
GBP 19 x 1,000 shares = GBP 19,000 total share premium.Case study
Seen in the real world.
BrightRetail, a growing clothing chain, needed to raise funds to open three new stores. The company originally issued 10,000 shares at a nominal value of GBP 1 each. Due to strong brand loyalty and steady profits, new investors were eager to buy in at a price of GBP 25 per share. BrightRetail issued an additional 4,000 shares at this price, raising a total of GBP 100,000.
On the balance sheet, the transaction was split carefully. The nominal value of GBP 4,000 (4,000 shares multiplied by GBP 1) was added to share capital. The remaining GBP 96,000 (4,000 shares multiplied by the GBP 24 difference) was credited to the share premium account. The finance director explained to the board that while the total cash injection was GBP 100,000, the GBP 96,000 share premium reserve was legally restricted capital. It could be used to absorb future equity-related expenses or issue free bonus shares, but it was strictly off limits for paying out the upcoming Christmas dividends.
Watch out
Common mistakes.
- Treating share premium as business profit and including it on the income statement.
- Attempting to use share premium funds to pay cash dividends to shareholders.
- Confusing the nominal share value with the actual market price paid by investors.
Questions
People also ask.
Can share premium be used to cover company losses?
Generally no, unless the company goes through a formal capital reduction process approved by the courts or shareholders, depending on local jurisdiction rules.
Is share premium considered an asset?
No, share premium is a reserve found on the equity and liabilities side of the balance sheet, representing where the money came from, not an asset itself.
Does share premium give investors extra voting rights?
No, voting rights are tied to the number of shares held, not the price paid for those shares.
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