Many companies elect to come to the market to raise capital in the form of unit offerings. They offer bundles of equity shares and warrants that they sell together as a package. However, the shares and warrants are traded separately in the secondary market. Sometimes companies also issue bonds with an attached equity warrant. These are similar to convertible bonds, except that the warrants can be traded separately. Companies also issue warrants as a ‘’sweetener’’ during restructuring or takeovers. Warrants may even sometimes be combined with Initial Public Offerings, or IPOs, given to investment bankers as a compensation for their underwriting services.
What Is a Warrant?
A warrant is very similar to an option. It is a financial instrument that can be traded similar to stocks and bonds. It gives the holder the right but not the obligation to buy ("call" warrant) or sell ("put" warrant) an underlying asset at a specified price (strike price or exercise price) by a predetermined date. The warrant expires on that date. Some can be used any time before that date, and others can only be used on that precise date. The price paid for this right is the "premium" and is generally less than that of the underlying asset.
Warrants Have Many Attractions
One advantage is that the expenses related to issue of warrants and initial servicing are very low.
Issuing warrants raises the image of companies because it reflects the confidence of investors in the company, who agree to purchase shares of the company at a price higher than the current market price. The company can gauge the level of confidence among investors through the sensitivity of the premium.
By offering warrants, companies pre-commit to another issue by giving the subscriber the right to buy shares at the exercise price at a pre-defined time. They financial instruments can help companies bring in equity financing in stages, thus resulting in reduced issue costs. Issuing warrants with an IPO increases the chances of success of the IPO, as warrants can be issued as a sweetener, i.e., an incentive to raise interest in new issues.
Disadvantages of Warrants
Despite the benefits, warrants may make an issue of shares unnecessarily complicated, since they create uncertainty about how many of their holders will exercise their right to acquire part of the company. They are also generally less liquid than options, which are traded on stock exchanges while warrants are generally traded in one-off, so-called "over the counter" transactions.
For investors, they can also be risky, since if the underlying stock price drops to below the strike price to buy or rises above the strike price to sell for a put warrant, the warrant is effectively worthless. If the company's stock becomes worthless, call warrants effectively become worthless as well. They also don't confer any of the voting rights ordinary stockholders receive.