Issuing of shares results in share premium or security premium as it is sometimes called. It may also lead to discounts on shares. Companies enjoy this when they have a good reputation or if investors believe in the future of the entity. Let’s discuss this here.
Definition of Shares Premium
1. Shares premium or security premium is the excess of the issue price of a stock over the authorized or par price.
2. It can also be defined as the extra price added to the authorized price of a stock through a public or private offering. Learn more on share premium. Read here
Issue price. This is the price the stock is sold to investors. It is different from the market price of the share. The issue price comes in during an initial public offering. For example, a company issues its shares at N50 per share to investors. The shareholders are expected to pay that price for every single share they acquire.
However, the market price arises when the shares are sold by a shareholder to another person in a stock exchange. The market price can be higher or lower than the issue price resulting in a capital gain or loss respectively.
Authorized price. This is the price of the share that is stated in the company’s prospectus and memorandum of association. When multiplied by the volume of shares, it is referred to as authorized share capital. This value can also be called a registered price. Why? It is the price registered with the company registrar during the registration of the company. Normally, this stock price should be lower than the issued price. In rare cases, it can be higher resulting in a share discount.
Public or private offering. Shares can be offered to investors either through a public offering or private placement. Public companies issued their stock using public offering. While private companies do so with the private placement.
For a public limited liability company, the public offering can be through a stockbroking firm or investment company registered in a recognized stock exchange. Such offerings are announced through the media. So that the public is aware and is free to invest in the company by buying its shares.
However, in a private placement, a venture capital firm or an investment company is used to aid such placement. But the sales are not announced through the media. Instead, the VC or broker will market the shares by meeting selected individuals or institutional investors privately.
How to Calculate Shares Premium
Shares premium is the excess of the issue price and the par price. To calculate it, these prices must be known. For example, if the issue price of John Bush Company is NGN 50, its market price is NGN 105 and the registered price is NGN 5. What’s the security premium?
Issue price = 50
Market price = 105 and
Par price = 5
Therefore, the security premium is NGN 50 – NGN 5. That is NGN 45 per share.
Another way to calculate it is using the value of the share instead of the per share. In the above example, assuming that the shares available for subscription is 100,000. Then,
Issue value = 100000 × 50 = 5,000,000
Market value = 100000 × 105 = 10,500,000 and
Par value = 100000 × 5 = 500,000
So, the shares premium is NGN 5,000,000 – 500,000. This equals NGN 4,500,000 (or NGN 45 × 100,000 = 4,500,000).
So far, you have learned that shares premium or security premium is the difference of issue price and par price of a security. It arises during an initial public offering (IPO) or an initial private placement. Here, investors pay higher than the price quoted at the company’s prospectus and memorandum of association.