A “warrant” is a based on an underlying security that assigns the owner the right, but not necessarily the obligation, to purchase an additional number of shares of the underlying security at a predetermined exercise price. The right remains in place for a preset period of time, ending on a specific date. The purchaser of the warrant typically gains that right at a lower cost than would be incurred with the outright purchase of the common stock of a company.
Companies sell rights, options and stock warrants to raise additional capital for operations, sometimes in the short-term. They provide an additional source of capital to the company.
Stock Warrants vs. Rights vs. Options: What’s the Difference?
A stock warrant is a contract entered into between an issuing company and its investors. It grants those investors the right to trade the company's stocks at an agreed-upon stock price. This must occur at a predetermined period of time. Options are made up of these warrant contracts.
Companies issue warrants and trade options on the exchanges, and they may issue them to compensate workers and others for services. The Internal Revenue Service indicates that options give these individuals the right to purchase shares of the company for which they perform work, usually at the current market price as of the day the stock options are granted.
An investor's option to buy or sell these stocks below market price is referred to as a stock right, according to the Corporate Finance Institute. Investors can purchase new shares of certain stocks at a discount.
Characteristics of Warrants
To better understand what a warrant is, common stock must be understood first. Common stock is actual ownership of a publicly traded company – it’s equity. Its value is determined each time it trades in the open (stock) market. The stockholders of common stock have an actual stake in the profit (or loss) of the company.
Warrants simply give the holder a right to purchase the common stock at a later time. Warrants have an expiration date. They offer no equity stake in a company, but they do have value.
Risk Factors of Warrants
Any stock will carry some amount of risk, but the risk factors of warrants differ. Common stock value is tied directly to the profitability of the company. As the worth of a company increases, the value of the equity and stock increases. The opposite is also true: The value of the stock declines if worth declines.
Warrants aren’t equity so they can’t directly participate in the profitability of a company, but their value is dependent on the specific price of the stock and the term remaining until its expiration date. Warrants are typically used to entice potential financial commitment from investors. They’re often initially attached to a company-issued stock or bond offering when a company has an unusual need to raise capital. That unusual need can be an additional risk factor.
An Example of a Warrant Offering
This simple illustration is representative of warrant offerings:
Company ABC needs to raise money and is about to make an initial public offering (IPO). It’s filed to offer 3 million shares of stock at $10. The company is unsure if it can sell all those shares, so it attaches one warrant to each share at no additional cost to make the offering more attractive. This warrant will permit the purchaser of this initial offering to buy one additional share at the same initial price within ten years of the IPO.
First, the new company may fail, in which case the stock and warrant are worthless. Second, the new company may succeed, but not as much as anticipated. If the common stock doesn’t appreciate above $10 per share at the expiration of the warrants, the warrants have become worthless. The stock is worth the current market value.
Finally, the company may be very successful, and its share price for the common stock rises to $40. The investor who purchased the IPO can exercise his warrants and take possession of the additional shares with a gain in value within the first 10 years.
Is a Warrant a Liquid Asset?
Sometimes warrants have no secondary market in which to make a transaction, but warrants can also be registered by the issuer and traded on an exchange. The value of the warrant can be tracked through quote sources online or in print in this event, or through a broker. The security usually has the symbol of the underlying stock with an additional “w.” or “wt.” attached to it.
Warrants are similar to options with respect to rights of ownership or transfer of risk. They can be a useful tool, but they have no inherent value unless and until they’re converted to common stock.
Call vs. Put Warrants: What's the Difference?
There are different types of warrants. A call warrant is the right to buy shares from the company that's issuing them. A put warrant is the current shareholder's right to sell the shares back to the company, according to Pulley.
Most private companies only issue call warrants. The price at which a call option or a put option can be exercised is referred to as the strike price.
A naked warrant simply allows the holder to sell or buy a share.
Do Warrants Have Voting Rights Like Stock?
Warrant holders don’t have voting rights because warrants aren’t traditional stocks. They don’t pay dividends, either.
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