What Is Additional Paid-In Capital?
Additional paid-in capital—also known as "contributed capital in excess of par"—is the excess paid by an investor over and above the par value price of a stock. Additional paid-in capital occurs when an investor buys newly issued shares directly from a company at its initial public offering (IPO). You may think of additional paid-in capital as a profit that a company receives from stockholders when the company first issues its stock.
[Important: Additional paid-in-capital is recorded at the initial public offering (IPO) only; the transactions that occur after the IPO do not increase the additional paid-in capital account.]
Additional Paid-In Capital
How Does Additional Paid-In Capital Work?
Investors may pay any amount greater than par
At its IPO a firm may ask any price for its stock and an investor may pay any amount above its par value, which generates the additional paid-in capital.
As an example, a company issues one million shares of stock with a par value of $1 per share. At the IPO, investors bid on shares for $2, $4, and $10 above the par value. The shares ultimately sell for $11, and the company makes $11 million. The additional paid-in capital is $10 million ($11 million minus the par value of $1 million). The company records on its balance sheet: $1 million as "paid-in-capital," and $10 million as "additional" paid-in capital.
And after the IPO?
Once a stock trades in the secondary market though, an investor may pay whatever the market will bear. When investors buy shares directly from the company, the company receives and keeps the funds as paid-in-capital. When investors buy shares in the open market, then the funds go to the investor who's selling them.
Understanding Additional Paid-In Capital Further
Adds to shareholders' equity
Additional paid-in capital is an accounting term, whose amount is generally booked in the shareholders' equity (SE) section of the balance sheet.
Because additional paid-in capital represents money paid to the company above the par value of a security, it's important to understand par. Companies assign a par value to stocks at the time of their IPOs, before there is even a market for the stock. Traditionally, the issuer sets the stock's par value arbitrarily low—even as low as one cent per share—because of state laws, and to avoid any potential legal liability if the stock drops below its par value.
Market value is the actual price that a financial instrument is worth at any given time. The stock market determines the real value of a stock, which shifts continuously as shares are bought and sold throughout the trading day. Thus, investors make money on the changing value of a stock over time based on company performance and investor sentiment.
- Additional paid-in capital is the difference between the par value of a stock and the price that investors actually pay for it.
- To be "additional" paid-in capital, an investor must buy the stock directly from the company at its IPO.
- The additional paid-in capital is usually booked as shareholders' equity on the balance sheet.
Why Is Additional Paid-In Capital Important?
For common stock, paid-in-capital consists of a stock's par value and additional paid-in capital. Additional paid-in capital can provide a significant part of a company's equity capital before retained earnings start to accumulate, it is an important capital layer of defense against potential losses after retained earnings have shown a deficit. Short of any retired shares, the account balance of paid-in capital, specifically the total par value and the amount of additional paid-in capital, should remain unchanged as a company carries on its business.