Capital Premium Finance – Objective, Function, and More
The issue or capital premium is the additional value that the shareholder pays for the shares that he acquires through his contribution. The problem or capital premium paid by the new shareholder seeks to protect the old shareholders so as not to lose their share of the company’s share capital.
The issue premium is a concept used when a company in operation has to raise capital. The most exact definition that applies to it is that of the dividend that must pay for a share about its nominal value. Suppose we want to approach it another way. The issue premium is part of the additional contribution. We have to pay when subscribing to a new share or participation. It is nothing more than the difference between the value at which new share issues and the nominal value of the existing ones. The first issue is account for in the company’s reserves to increase its solvency.
The Objective of the Capital Premium
The essential objective of this premium is to protect old shareholders against new ones who enter a business that is already in operation. Where the most critical investments have already been complete, which has a client portfolio, etc.
Let’s say that during its lifetime, the company has generated “reserves”. Whose value remains fixed regardless of whether or not the number of shares increases as the reserves are before this capital increase. The founders decide that the new partners pay more for each share to avoid the so-called dilution effect or, what is the same, the loss of value of their claims.
What is the Function of the Capital Premium?
The issue premium is protective towards shareholders already part of a company compare to those who join in a capital increase. The issue premium always compensates for the more excellent value of the shares already issued. So it has a solid equalizing character and tries to avoid the economic punishment of former shareholders.
We can see it as follows. Imagine that a company issues new shares to increase capital. Investors can decide how they want these shares publish.
- The first is that the newly issued shares are allotted at par. In this way, when a shareholder joins the company, he will pay the value of the pre-existing shares. It is rarely realistic because the company is usually worth more at the increase than the par value of the existing shares.
- Set an issue premium. In adding to the nominal value of the issued shares. A bonus or surcharge pay allows the accompanies actual situation to be valuable. It prevents the old shareholders from diluting their shares. In other words, those who join the company will have to pay a premium that will try to compensate for the benefits that these shares have been providing. When they have been active.
It is a widespread movement because those who have been shareholders in a company from the beginning assume a more significant number of risks. The mission bonus can also be usual with generated. However, as we said, the typical objective is not to dilute the old shareholders.
How is the Capital Premium Calculated?
The issue premium, which we call PE. Is the difference between the issue value VE of these new shares and their nominal value VN.
PE = VE – VN
It is unspoken that what the new partners who join the company have to pay corresponds to the nominal value of those shares and the issue premium that agrees.
The Capital Companies Law refers in article 298 to the increase in capital. It establishes, in section 1, that in increases in share capital. The creation of social participations and the issuance of shares with a premium will be lawful. On the other hand, section 2 specifies that best pays in full at the assumption of the new company participations or the subscription of the new shares.
Therefore, we face a concept that protects those who took risks at the time in creating a new company. When everything is going from strength to strength, it is easy to jump on the bandwagon. So the share premium establishes a compensatory character towards the old shareholders, avoiding its dilution with the entry of new partners.
Why this Method is Use?
Who already own shares of a company due to the entry of new partners. So that they do not lose the percentage of ownership of the company they already had this method uses to protect the partners. In other words, it avoids what is known as the “dilution effect” of the share. The loss of theoretical value of the claims that existed before the capital increase.
- On the other hand, the company’s balance sheet strength since the premium value adds to the company’s reserves.
- If it were the case that only those who are already partners of the company bought new shares in the capital increase. The assumption premium would not make sense. But this is usually not the case.
- The operation and regulation of this financing method are included in Royal Legislative Decree 1/2010, of July 2, of the Capital Companies Law.
- In a capital increase with new shares, this type of financing is called issue premium.
The Assumption Premium in Company Accounting
The assumption premium must precisely appear on the company’s balance sheet as a liability. Its value, therefore, is not accounting for as the share, whose value would go directly to the company’s share capital :
Deal of the new shares: 10,000 euros
Value of the assumption premium: 2,000 euros
These 2,000 euros are not part of the company’s capital but rather as own resources. As money that the company can use for its operations, purchases, payments, etc. The assumption premium uses to strengthen the company’s financial situation.
Any limited company can carry out a capital increase with an assumption premium. However, it is an instrument widely use by newly created companies or start-ups. They is successful but need more resources to continue expanding or to pay the debts incurred to start the business.
The issue or capital premium is the additional value that the shareholder pays for the shares that he acquires through his contribution. It produces by the new shareholder. Who seeks to protect the old shareholders from losing their share of the company’s share capital.
Likewise, it protects former shareholders because their shares do not lose value. The profits and benefits obtained from the effort and risk involved in starting a business are not attribute directly to the new shareholder after the contribution. The capital increase with an issue premium prevents the old shareholders from losing company control.
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