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 share premiums, how they come about, and the legal implications of having a share premium account. 

What is a Share Premium?

A share premium is the amount of money investors pay for a company’s shares that exceeds the nominal value of those shares. In other words, it is the difference between what investors pay for newly issued shares and the face value of the shares. The company records this excess amount separately from the share capital on its balance sheet.

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. However, you can select a nominal value, such as £0.01 per share. 

Companies should not set a high nominal value, as this amount becomes the minimum amount that shareholders must pay for their shares; in other words, it is a debt that the shareholder owes to the company.

Later, after your company has generated revenue and become successful, the nominal value of your shares may be considerably less than the market value. 

Consider the following example. 

FamCo Ltd

Suppose you and your sister start a company, FamCo Ltd. You transfer £5,000 to FamCo, and so does your sister. In exchange, each of you receives 5,000 shares. The nominal value of these shares would be £1 because 10,000 shares correspond to your company’s share capital of £10,000. 

Five years later, your friend approaches you and asks if he can invest in your company. They have £10,000 to invest. 

How Many Shares Would You Give Him? 

To answer this question, you need to know your company’s value. 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 

Let us say you hire an accountant, and she values your company at £100,000. 

Given that your company is worth 10 times what it was (roughly speaking) when you incorporated it, you would probably want to receive 10 times as much per share. 

In other words, your shares would now be worth £10 (10 x £1). Therefore, a fair value for your buyer would be 1,000 shares (£10,000 / £10). 

Shares

In FamCo’s case, of the £10,000 given to FamCo in exchange for 1,000 shares, FamCo must use £1,000 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 such as with Partially Paid Shares.

You must record the sale of the shares for an additional £9,000 in the share premium account.

Legal Implications of the Share’s Nominal Value  

This means the actual nominal value of your shares does not significantly matter as 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 for services rendered to the company). 

Changing the Nominal Value of Shares

A company can change the nominal value of its shares when it splits them. A share split occurs when a company subdivides its existing shares. For example, a company could split 100 shares, each with a nominal value of £1 (i.e., a total nominal value of £100 for all shares), to 1000 shares, each with a nominal value of £0.10 (i.e., still a total nominal value of £100 for all shares). 

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Companies often split shares when bringing in investors to ensure they can give an investor shares without involving fractional shares. It is much easier to offer an investor a 33% stake in a company with thousands of shares instead of ten shares. If you plan to bring in investment to your company, consider splitting your shares to keep shareholdings as simple as possible.

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 in the company’s share premium account. The effect is that the money raised cannot be used for certain things, like issuing dividends to shareholders. 

If you need help understanding share premium monies, 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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