Companies that are in growth mode may find it useful to issue warrants for equity in the company. A warrant is a document that gives the holder the right to purchase a certain amount of stock of the company at a date in the future, at a set price (known as the exercise price). The holder is not obligated to buy the stock, but rather has the option to choose to buy it.
Warrants are often given as deal sweeteners, and are sometimes referred to as “equity kickers” in an investment deal. The benefit to the holder is that he or she can purchase the stock in the future at an exercise price set today. The exercise price may turn out to be significantly lower than the value at the time the actual purchase is made. The benefit to the issuer/company is that the primary deal terms may be more attractive if there is an equity kicker attached – for example, the interest rate on a loan may be set lower or the principal amount may be increased if warrants are included in the deal, as the investor may consider the warrant value as part of its overall potential return on the transaction.
The holder of a warrant is not a stockholder in the company (at least, not by virtue of holding the warrant), and does not have voting rights. Stock ownership and voting rights come only upon exercise of the warrant, when the stock is actually acquired and held. Nonetheless, the company must always reserve adequate unissued stock during the time the warrant is outstanding, in case the holder chooses to exercise the warrant and receive the stock. The warrants and the stock reserved for them are typically reflected on the cap table for the company, so that everyone knows how much stock is subject to warrant exercises at any given time.
The warrant will also have an expiration date, beyond which it cannot be exercised. Depending on the deal, the expiration date may be many years away. The longer the term of the warrant, the greater the potential benefit to the holder, as it is expected that the company will grow over time and the value of the equity may increase substantially.