Issue of a share at par and at a premium

In general, an ordinary share in India is said to have a par value (face value) of Rs.10, though some shares issued earlier still carry a par value of Rs.100.  Par value implies the value at which a share is originally recorded in the balance sheet as equity capital. Equity capital is the same as ordinary share capital. The SEBI guidelines for public issues by new companies established by individual promoters and entrepreneurs, require all new companies to offer their shares to the public at par, i.e. at Rs.10.  However, a new company set up by existing companies (and of course existing companies themselves) with a track record of at least five years of consistent profitability are allowed by the SEBI guidelines to issue shares at a premium.

It should be noted that when a company issues shares at a premium, it is able to raise the required amount of capital from the public by issuing a fewer number of shares.  For example, while a new company promoted by first time entrepreneurs intending to raise say, Rs. One crore, has to offer 10 lakh ordinary shares at Rs.10 each (at par), an existing company may arise the same amount by offering only 2.5 lakh shares at Rs.40 each (close to the market value of its shares).  The latter is said to have issued its share at a subscription price of Rs.40 (Rs.10 in of the former case), at a premium of Rs.30 (being the excess of subscription price over par value).  In such a situation in India, the company’s books of accounts will show Rs.10 towards share capital account and Rs.30 towards share premium account.

It can readily be seen that the higher the premium, the fewer will be the number of shares a company will have to service.  For this very reason, following the policy of free pricing of issues in 1993, many companies came out with issues at prices so high that in many cases they were higher than their market prices, lending to under-subscription of such issues.  The companies are however learning fast about the pitfalls of high pricing of shares and it is only a matter of time before the issue prices become more realistic.

In India, no company is allowed to issue shares at a discount, i.e., at a price below par, again, in India, once a company has issued the shares, it cannot easily reduce its capital base, i.e., buy back or redeem its own shares.  This means that ordinary share capital is a more or less permanent source of capital, which normally a company is never under an obligation to return to the investors.  This is because a shareholder who wishes to disinvest (i.e., get back the invested capital) can always do so by selling the shares to other buyers in the secondary market.  Also, in India, a company receives no tax benefits for the dividends distributed.  In other words, dividends are paid by the companies out of the earnings left after taxes and they get taxed once again at the hands of the investors.

A company cannot raise equity capital in excess of the limit authorized in its Memorandum of Association (a document detailing the terms and conditions under which a company is incorporated under the company law) at any time, without undergoing certain legal formalities.  This limit is known as authorized capital. At any point of time, the actual amount of capital issued by a company may be only a part of the authorized capital, and is known as issued capital.  Again, not the entire capital issued by a company is necessarily required to be fully paid up at any time.  This is because a company may chose to ask for only a fraction of the value of the share initially, to call the balance in installments, calls calls. For example, a company may issue a Rs.10 share, and require the investors to pay up only Rs.5 initially.  The remaining Rs.5 may be called in one or more calls.  The amount of capital paid up at any point in time is known as the paid-up capital. Again, while an investor may apply for, say, 100 shares at a subscription price of Rs.20 fully paid up, he may be allotted only, say, 10 shares by the company.  The application money of the investor on the 100 shares applied is Rs.2000 (100 x Rs.20).  The company would refund the balance of Rs.1800 (Rs.2000 – 200) to the investor, since he is allotted shares only worth Rs.200 (10 x Rs.20).

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