Issuing Warrants to Investors
Friday, 05.18.2007, 10:50am (GMT)
When raising capital for a business venture, warrants are a
common form of equity that is given to investors. A warrant is like an option –
it gives the holder the right to buy a security at a fixed or formulaic price,
which is known as the "exercise" or "strike" price.
Warrants are often
confused with options. Options, as used in the venture capital space, are
typically long term (up to 10 years). They are also typically issued to
employees versus investors. Conversely, warrants act like short-term options
and, unlike employee options, can be traded as an independent security.
In general, neither the issuance of warrants nor their exercise (at
least by non-employees) is a taxable event. In fact, in 1984, Congress reversed
the earlier position of the IRS that the expiration of a warrant is a taxable
event for the issuer. However, whenever a debt security with warrants attached
is issued as a package, original issue discount problems are invited.
One type of warrant that once popular as a financing mechanism for
emerging ventures is contingent warrants. These warrants become exercisable if
and when the holder does something for the issuer, for example buys a certain
level of product. Contingent warrants are no longer used often since the SEC
ruled in favor of current and periodic recognition of expense to the issuer.
Like an option, a warrant is considered a "common-stock equivalent†for
accounting purposes. And, if the warrant has been "in the money" (i.e., the
exercise price is below the market price) for three consecutive months, it is
deemed to impact earnings per share under the so-called treasury-stock method.
That is, the warrants are considered exercised, new stock is issued at the
exercise price, and the proceeds to the issuer are used to buy in stock at the
market price.
Warrants are a common financing mechanism and companies
seeking venture capital should consider and become knowledgeable about this type
of equity device.
About the author:
GT Business Plans has developed over 200
business plans for clients that have collectively raised over $750 million in
financing, launched numerous new product and service lines and gained
competitive advantage and market share. GT Business Plans is the sister site of
GT Venture Capital
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