Share premium: What is it and how does it work?

If you need to raise money for your company, a share premium can be an effective way to do it. This article outlines the advantages and disadvantages of using a share premium account, explains how to compare nominal and market value, and provides guidance on managing legal and accounting requirements in this context.

Understanding share premiums

Share premiums are a useful alternative to loans when funding your business. But they are governed by the Companies Act and require some detailed understanding.

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During the formation of your company, you, as the founder, will allocate a certain number of shares, say 100. You can set any value you want for these, but companies usually use a low price, say £1 each, as it gives flexibility for future fundraising and growth.

This becomes your fixed nominal share value (also known as the par or face value). It’s the lowest possible price at which you can sell your shares. If you own all 100 shares and they have a nominal value of £1, your personal financial exposure in the event of company insolvency is limited to £100 – this is known as limited liability.

Market versus nominal value

This nominal value is arbitrary and usually bears little relation to the market price, which is what a new investor pays for your shares when you sell them to fund your business. The market value changes constantly, based on your company’s financial performance. Over time, the market value may grow if your company performs well and attracts investor interest.

The share premium is the difference between the nominal value and the market value when you sell those shares. The value of your nominal shares is called your share capital. Share capital and share premium must be recorded as distinct line items in your balance sheet.

Why issue new shares at a premium?

To raise finance for your company, you can either use debt, such as bank funding or a director’s loan. Or you can increase your share capital by issuing shares at a premium. The latter has several potential benefits:

• Issuing shares at a premium ensures that the selling price reflects the company’s true market value.
• Creating share premium raises funds without changing the number of shares. This avoids reducing the ownership percentage for existing shareholders (known as equity dilution), which impacts their control and dividend entitlement.
• If you raised a loan, this would appear in your accounts as a liability. Too many liabilities could raise concerns for anyone evaluating your company’s financial security, such as a bank or potential buyer. Share premium does not record debt against your company.

Richard Coulthard, director & head of commercial at Ison Harrison Solicitors, gives this example. “If you have 1,000 ordinary shares with a nominal value of £1 each, your share capital is £1,000. If your company needed to raise £10,000 to fund operations, the shareholders could allot more ordinary shares at nominal value, so there would be 10,000 shares of £1 each. However, this would permanently alter the company’s ownership.

“Instead, they could allot a share premium of £9,000. This still raises £10,000 (the nominal value plus the premium), but the number of shares stays at 1,000, and the company adds a separate premium of £9,000 on the balance sheet.”

This would also be a way for a shareholder to put more capital into the business without creating a liability through a loan, adds Coulthard.

What is a bonus share issue?

Another common motive for raising share premium is to give existing members and staff (via an employee share scheme) a bonus by way of an equity stake that reflects the company’s market value. This “bonus issue” allows the company to reward its staff or shareholders while retaining profits in the business that could otherwise be distributed as dividend payments.

For example, a company might use its £4,000 share premium to issue bonus shares to rebalance its capital structure and acknowledge growth without cash distribution.

How to account for share premiums

The Companies Act governs the way you account for share premium, so we strongly recommend you get professional advice from an accountant.

Setting up the share premium account

According to the Act, any premiums received on shares must be recorded separately in the “share premium account” (SPA) in your company’s books. This is not a separate, physical bank account – it is simply the name of an accounting entry. The funds in this account are classified as non-distributable reserves.

This means the money cannot be treated as profit available for general purposes, such as paying dividends to shareholders or offsetting operating losses. This ensures the capital remains intact to guarantee repayment to creditors and prevent the unlawful dissipation of assets.

Instead, share premium funds can only be used in limited ways, such as paying expenses related to share issuance, and issuing fully paid bonus shares to existing shareholders.

Share premium is recorded at the bottom of the balance sheet in the capital and reserves section and is unaffected by changes in your company’s profit and loss.

Potential risks

Share premiums can come with challenges. “One is that removing or cancelling share premium is typically done by issuing further bonus shares or by a reduction in capital, which may involve complex processes,” says Coulthard.

The SPA is legally separate from the shares that create it. “The effect of this separation is that a shareholder who has paid share premium does not have an automatic right to be repaid that premium when the shares are transferred, cancelled or bought back,” says Coulthard. “Such transactions do not impact the SPA unless you undertake a formal process for reducing share capital.”

Such a process can be expensive and time-consuming.

Can a company sell shares for less than market value?

You don’t have to issue shares at a premium, and you can sell them for less than their market value. However, you cannot issue fully paid-for shares at a price below the nominal value. If you issue shares as unpaid or partly paid, the unpaid amount remains due and must be remitted to your company upon request.

You can fund these partly- or fully-paid shares from your own reserves. This enables you to issue shares at a discount or for free, for example, as bonuses for existing members or as part of an employee share scheme.

Existing shareholders can transfer their shares for any value or even give them away, for instance, to their spouse or children. If you don’t know where to begin, at 1st Formations, we can support you thanks to our Transfer of Shares Service.

How to calculate market value

There is no fixed formula for valuing shares in a private limited company. Often, a company’s Articles of Association and Shareholders’ Agreement specify the method for valuing its shares. It’s typically a complex calculation, depending on a wide range of factors, including:

• Your assets and liabilities.
• Turnover, profits, and cash flow.
• Profitability forecasts.
• Economic climate and interest rates.
• Performance of similarly sized businesses in your industry.
• Reputation and brand strength.

Assessing fair value can be particularly difficult in a private company where there is no open market for the shares, and where many fast-changing factors are at play. Incorrect or disputed valuations can lead to expensive court cases. We strongly recommend using an experienced independent valuer, such as an accountant.

Share premium: Common pitfalls and tips

Issuing shares at a premium carries operational and compliance implications for limited companies:

• Shares must always be issued for at least their nominal value. Issuing shares at a discount is generally prohibited and can expose directors to liability.
• Companies must review their Articles of Association and secure shareholder authority to allot new shares if issuing to outsiders.
• The board must approve the issue price.
• The company must file Form SH01 (Return of Allotment of Shares), which includes the statement of capital and details the premium, at Companies House within one month. Omitting these legal requirements could result in penalties or delays.
• When new investors enter due to a premium issue, it’s best practice to update or establish a Shareholders Agreement to cover decision-making and transfer restrictions.

Start smart

Launching your company and issuing shares are critical steps that lay the groundwork for long-term success. From choosing the optimal corporate structure to designing a compliant and strategic capital setup, expert guidance can save you time, mitigate risk, and position your business for growth.

Whether you’re a startup founder or looking to formalise an existing venture, our team at 1st Formations is here to support your journey every step of the way – from initial setup to ongoing compliance – ensuring your company starts on the strongest possible footing.