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, such as one cent. 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 clarifies 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. Imagine buying a branded cinema ticket printed with a face value of $1, but because the film is so popular, you gladly pay $15.
The cinema keeps the extra $14 in a special fund for upgrading the theatre, rather than spending it on daily snacks.
In practice
Real-world examples
Example 1
TechStart issues 10,000 new shares with a nominal value of $1 each, but investors pay $15 per share. The $140,000 difference goes straight into the share premium account, while $10,000 goes to share capital. The finance team records the two amounts separately on the same day.
Example 2
Baker & Sons bakery issues 5,000 shares with a nominal value of $10 at an issue price of $50. This generates $200,000 in share premium, in addition to $50,000 of share capital, to fund a new commercial oven. The owners keep the premium in reserves rather than treating it as spendable profit.
Example 3
GreenEnergy Ltd issues 50,000 shares with a nominal value of $0.10 for $5 each. The resulting share premium of $245,000 strengthens the balance sheet for a major expansion. The nominal amount of $5,000 is recorded as share capital.
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
Worked example: a company issues 1,000 shares. The nominal value is $1, but investors pay $20. The premium per share is $20 - $1 = $19, so the total share premium is $19 x 1,000 = $19,000. The share capital account increases by 1,000 x $1 = $1,000, and the total cash received is $1,000 + $19,000 = $20,000.
Share premium can also be used to see what a later bonus issue would do. If the company later issues one free bonus share for every ten held, it creates 100 new shares with a nominal value of $1 each, which requires $100 to be moved out of the share premium account. The premium account would fall from $19,000 to $18,900, and share capital would rise from $1,000 to $1,100, with no change in total equity.Case study
Seen in the real world
This is a fictional, illustrative scenario. 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 $1 each. Due to strong brand loyalty and steady profits, new investors were eager to buy in at a price of $25 per share. BrightRetail issued an additional 4,000 shares at this price, raising a total of $100,000.
On the balance sheet, the transaction was split carefully. The nominal value of $4,000 (4,000 shares multiplied by $1) was added to share capital. The remaining $96,000 (4,000 shares multiplied by the $24 difference) was credited to the share premium account. The finance director explained to the board that while the total cash injection was $100,000, the $96,000 share premium reserve was 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.
Later, the company spent $6,000 on legal and advisory fees to complete the share issue. Because these were direct costs of raising equity, the finance director deducted them from the share premium account, reducing it from $96,000 to $90,000, rather than charging them to profit. The board saw that the new capital had cost 6% of the money raised, which helped it compare equity funding with a bank loan.
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.