How Do Share Premiums Work?

Are you curious about what happens if you issue shares in your company for more than their nominal amount? Does this form part of your company’s share capital? Or are you free to do with the proceeds of the equity raise as you wish? This article explains what share premiums are, how they come about, and the legal implications of having a share premium account. 

Nominal vs Market Value

We define the nominal value of the shares as the face value of the share, or the value as recorded at Companies House. 

Often, for small businesses, the nominal value of your company’s ordinary shares is £1 because this was the default value when registering your company with Companies House. 

Later on, after your company has been quite successful, the nominal value of your shares may be quite a bit less than the market value. 

Consider this example. 

FamCo Ltd

To answer this question, at the very least, you would need to know the value of your company. In practice, you would also want to know what sort of returns your investor was looking to gain, but this is a simplified example. 

To calculate your company’s value, you would need to conduct a valuation of your business. 

Understanding FamCo’s Share Premium 

In FamCo’s case, of the £10,000 given to FamCo in exchange for 1,000 shares, £1,000 of that must go to pay the nominal value of each share. This is because the nominal value must always be paid up on issued shares (subject to certain exceptions). 

You will have to record the fact that you have sold the shares for an additional £9,000 in what is called the share premium account.

Legal Implications of the Share’s Nominal Value  

Thus, you can see that the actual nominal value of your shares does not matter significantly, so long as they are paid up to that amount. 

Regardless of the nominal value, you must always issue your shares for at least this amount. You cannot issue shares for less than this (though you could issue shares for non-cash consideration, such as property transfer). 

Legal Implications 

The law requires you to transfer the share premium, the difference between the market value and the nominal value, to the share premium account. 

Despite its name, this does not require you to have a separate bank account in which this money must sit. Instead, this refers to a legal accounting requirement. So, effectively, your company cannot issue this amount back to shareholders as a dividend payment to existing shareholders. 

This is because any amount raised in equity financing over the nominal amount still counts as part of the company’s share capital. 

This is because the company’s share capital should reflect the extent to which it can meet any liabilities.  

Practical Implications 

Practically, companies raise equity financing to fund an activity. Some common examples include:

• buying another company; 
• opening an office in another geographical market; or
• paying off debt. 

Because equity is a proxy for a measure of ownership in a company, the law does not permit a company’s equity value to drop below the amount raised in equity. 

Therefore, a company’s share account is part of its non-distributable reserves because it reflects the shareholders’ equity in the company. 

The actual cash you raise through the equity financing is different from the underlying equity you hold on the company’s accounts. 

So long as the cash value raised by the equity is put towards something productive, such as paying off a debt (which reduces a liability) or acquiring an asset (which increases the company’s assets), they comply with tthe law.

Additionally, you can also use cash raised through a share premium to write off expenses or pay up new shares allotted to members as fully paid bonus shares. 

Key Takeaways 

A company share will be issued at a premium if the investor has paid the company more than the share’s nominal value. A company’s nominal share value is the price recorded at Companies House. This figure is often £1 (or £0.10) in practice. If a company has grown in value, it is common for the market value to exceed the nominal value. By law, you must record the difference between the price paid (the market value) and the nominal value and record this amount to the company’s share premium account. The effect of this is that the money raised cannot be used for certain things, like issuing dividends to shareholders. 

If you need help understanding what you can and cannot apply share premium monies toward, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.

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