Should you buy shares issued at the premium price?

The shares available in Indian share market of any company have a par value or Face Value (FV). The face value of shares is usually Rs. 1, Rs. 2, Rs. 5, Rs. 10 etc. The FV has to be a positive integer whole number. It cannot have a fractional value like Rs. 1.50 or Rs. 2.25. The shares which are issued in the market are usually issued at a premium price.

premium shares

Let us take an example to understand what shares issued/offered at premium price means.

ABC Company’s share has a face value of Rs. 2 per share. During its public launching (IPO) the company decides to issue shares at Rs. 50 per share in the market. The shares are issued at a premium. That is more than its face value. You can calculate the premium thus.

Premium per share = issue price – face value

As per our example of ABC Company, the premium per share can be calculated as follows

Premium per share = 50 (Issue price) – 2 (face value) = 48

In other words, the face value per share is Rs. 2, Premium is Rs. 48, and the issue price is Rs. 50.

Let us go deeper to understand the concept of why companies issue shares on the premium price and not the face value.

Equity financing

When any company plans for expansion or additions to the existing line of business and grow big the individual owners or partners require funds or the company requires funds for further modernization and expansion. They can get funds through banks, NBFI, or the general public or it can raise funds through equity route or debit route.

When the promoters take the equity route that is called equity financing, the company or its promoters sell a portion of their holding to the public. The number of shares which can be issued to the public is limited by authorized capital. AC is the capital that can be raised which is a total number of shares multiplied by its face value. The authorized capital is mentioned in the company’s MoA (Memorandum of Association). MoA is prepared by the company at the time of its registration and is a legal document which has to be submitted to SEBI (Securities and Exchange Board of India) along with other documents.

It should be noted that the company cannot issue more shares than the number indicated in its MoA. It can raise more capital by issuing shares at a premium.

The reason why the shares are issued at a premium

As stated above the company needs cash for the modernization and expansion plans of its business. As the company wishes to go public that is promoters are ready to dilute their shareholding. Since the company is in businesses for the last several years it develops goodwill among the public, an established brand of product, and a reputation in its line of business earning sufficient profit. When it issues shares at a premium it has two advantages, firstly short term that is higher the premium, less is the number of shares that it has to issue in the market and promoters holding remains higher. Secondly, the long-term benefit is that if shares issued are less the dividend per share is higher. In other words, the existing shareholders will get a better dividend yield. Since promoters’ holding percentage is more, a number of shares held by them are more and they get a larger share of the dividend.

If the premium is higher it has twin advantage for the company and its promoters. They are able to generate the required capital for their expansion plan and holding a larger portion of shares of the company. In future, they can buy-back shares from the public to further strengthen their hold on the company.

It is seen from time to time the company buy-back its shares from the share market when the promoters feel that the share price is undervalued in the market and increase their holding. Promoters know the functioning of the company so they buy their undervalued shares and when in future their share price increases they sell it and book profit. On the other hand just to fool investors and drive up the share price of their company the promoters go in for a buy-back.

If you are undecided that shares should be purchased at the premium price they are offered at or not, you can contact us and we will be glad to solve your query.