A Stock Warrant provides the holder with the right to buy the stock of the company at a pre-determined price in a particular time period and when the stock warrant is exercised by the holder, the holder purchases the stock of the company and the company receives such money as its source of capital.
Stock Warrant Meaning
Stock Warrant or Share Warrant is the right to purchase the shares of a stock at a certain price and within a stipulated time period. It expires after a certain point of time if the investor does not exercise them. However, the holder of a stock warrant has the right to deny the purchase i.e. he is not locked in to purchase the stock.
In case of a share warrant, the investor pays a nominal amount to buy a warrant which gives him the right to purchase shares in the future. This is good for both the investor as well as the Company. The investor has only paid a small amount and he can decide to whether purchase shares in the future depending on the performance of the Company. It is good for the Company as the Company gets additional capital which it can use to boost up its revenue by deploying the capital in profit making projects.
Types of Stock Warrants
There are two types of Stock warrants:
#1 – Call Warrant
A call warrant is the right to buy a specific number of shares from a Company at a certain price with a given time period.
#2 – Put Warrant
A put warrant is the right to sell a specific number of shares to the Company at a specific price within a given time period.
Why Companies Issue Stock Warrants
Stock warrants are issued by the Company due to many reasons which are favorable to the Company. Some of the reasons to issue stock warrant are as follows:
- It provides an additional source of capital to the Company for the future. A Company may issue it when it may seem its capital eroding but does not require immediate capital infusion. Thus, the issue it so as to have enough capital sources for the future.
- Stock Warrants attracts more investors and for the shares of the Company. Suppose the shares of the Company trade at $ 500 and the Company issues it at $ 50, it can get attraction from the investors who do not enough capital to purchase shares of the Company but they can purchase it so to keep the right to purchase shares of the Company in the future.
- It can preserve goodwill from the Company’s shareholders. The Company would find it easier to convince the shareholders to pay to say $ 50 than to pay $ 500. Thus, the Company will receive its capital while maintaining its reputation with the shareholders.
- Issuing it with other financial instruments will improve the Company’s attractiveness and reduce the cost of funding for the Company.
- If the warrant holders exercise their right to convert them into shares, it will boost the liquidity of the Company’s stock in the market.
Merits of Share Warrant
- Investors may choose to exercise it if the market price of shares of the Company is more than the exercise price of the warrant. Thus, the investors will receive shares at a price lesser than the market price.
- The dilution effect’s impact will be lesser for the shareholders as investors may choose to exercise their warrants.
- Warrants act as an alternative investment for the investors of the Company. Investors who wish to invest in the Company may do so by investing in the warrants. The investment cost of it is lesser than buying the shares of the Company and the market price of warrants is usually volatile than the Company’s share price.
Demerits of Share Warrant
- Like any other financial instrument, they are prone to market risk.
- Warrants are infrequently issued and thinly traded. Thus, there are not many options for the investors to choose amongst it and then have enough liquidity in the market for trading.
- The warrant holder is not the shareholder of the Company until he exercises the right when the time is due. Thus, the holder does not have the right to vote.
- A certain amount has to be paid upfront for it, which the investor may lose if he wishes to not exercise the right. If the share price is lesser than the exercise price in the warrant, the shareholder will be “out of money” and hence it will not be profitable for him to exercise the right.
- There will dilution impact on the existing shareholders and they can observe the dilution in market price and voting rights.
Limitations of Stock Warrant
While it issued by the Company have both advantages and disadvantages, they are prone to some limitations.
- The number of warrants, shares reserved for warrant exercise and shares reserved for the exercise of existing warrants shall not exceed more than 50% of the Company’s share capital
- The exercise price and the time of exercise have to be set by the Company. The Company should foresee the time and amount of the funds needed by it.
- Since they are thinly traded and issued by a few companies, they have to be provided with a better dal to gain investor interest.
- Warrants can be issued only by listed Companies.
Importance of Share Warrants
- It is a financial instrument that gives the investor the right to purchase shares.
- They have stated exercise price, time duration to exercise and date of expiry
- Investors have to purchase it by paying an amount which is some percentage of the share price of the Company
- It expires if the investor does not exercise his right and the investor loses his initial money invested while purchasing the warrant
Stock Warrants are a financial instrument that provides investors with an opportunity to invest and the Company with a source of funding. They are not very common in today’s world as fewer Companies choose to raise capital using it and they are thinly traded thus having less liquidity and attraction amongst investors. However, given their features, they can be a part of an investor’s portfolio but investment should be done diligently as any other financial instrument is also prone to risks.
This has been a guide to what are Stock Warrant (Share Warrants) and its definition. Here we discuss why companies issue stock warrants along with its merits, demerits & limitations. You can learn more about finance from the following articles –