Why Do Companies Issue Warrants?

by Ruchita Daga ; Updated July 27, 2017

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 (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 on the stock exchange. 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. The price paid for this right is the "premium" and is generally less than that of the underlying asset.

Warrants Have Many Attractions

Firstly, 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.

By issuing warrants, companies can have 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

Despite the benefits, warrants may make an issue of shares unnecessarily complicated.

About the Author

Ruchita Daga has been writing finance and business articles since 2005. Her article, "Disclosure and Corporate Governance: Evidence from India," has been presented at the BAM Conference in Sheffield. She is a chartered accountant and an analyst for a private equity fund. Daga holds a Master of Business Administration from Brunel University.

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