Stock warrant is a contractual agreement between the company and an investor or a bank, providing the holder with the right to buy company’s stock at a predetermined price.
One of the key elements of a stock warrant is the exercise price. It’s the price at which the warrant holder can purchase shares. Warrants also have expiration dates. These are the final days when an investor can exercise and purchase shares. Such a clause ensures warrants are not held indefinitely and there is a timeframe for holders to evaluate their investment decisions.
Stock warrant vs options
Stock warrants, like stock options, provide the holder with the right to purchase a specified number of shares at a predetermined price within a defined timeframe. However, there are key differences between the two.
- Holders: While stock options are typically issued to employees and have specific vesting schedules, warrants are commonly issued to investors and used in external fundraising.
- Expiration: Warrants often have longer expiration periods, making them more suitable for investors and strategic partners.
- Exercising: Warrants can be exercised at any time before the expiration date. Stock options typically have exercise windows, constraining the abilities to exercise and get stock.
- Vesting schedule: Both warrants and options can have vesting schedules. These can be time-based and performance-based, depending on the needs and wants for the agreement.
Benefits of Warrants for Startup Financing
Startup founders can use stock warrants as a form of leverage to attract investors during fundraising. There are 3 main advantages of warrants for startups:
- Sweeten the deal: Increase investor interest by offering potential gains and tying investor interests to the startup's performance. Investors may be lured in by the prospect of significant rewards if the firm succeeds. You can use warrants to increase your chances of securing the round.
- Offer investment flexibility: Startups can design warrants so that they can be exercised during later fundraising rounds. Such a structure can give investors the opportunity to participate in future rounds without having to immediately commit more capital. This flexibility may be especially helpful for firms that require several funding rounds to support their expansion.
- Keeping dilution under control: The founders can maintain their ownership positions while still raising money by issuing warrants rather than more shares. By using warrants, capital can be obtained with the least amount of immediate dilution to current shareholders. However, it’s critical to remember that when exercised, warrants will require issuing new shares which will dilute your existing stakeholders.
Issuing Stock Warrants for Startups
Issuing warrants in your startup’s journey requires you to consider a few important factors. Let’s get clear on the reasons, consequences and drawbacks of stock warrants for your startup and yourself.
- Terms and conditions: Agreeing on the warrants’ terms is critical to make sure the agreement serves its purpose. It involves clearly specifying the exercise price, vesting schedule, expiration date and the number of shares.
- Dilution: Determining the number of warrants to be issued is a critical step. The exercising of warrants means you will have to issue shares. And with share issuance comes dilution of existing shareholders. It’s key to strike a balance between attracting investors using warrants and managing dilution.
- Cap table: You will need to accurately account warrant issuance. Whether you are using Excel or an equity management software, it’s essential to keep a clear record of all the warrants and their details. Remember that the issuance of warrants does not have a direct impact on your cap table right away. You need to present them separately as they represent the potential right to the company’s stock. But once the warrants are exercised and new shares are issued, these will have to be added to the cap table with all the existing shareholders.
- Financial implications: The warrant exercising involves accounting and tax implications for both parties. Getting professional advice and seeking guidance will ensure you and your investors stay compliant during this process.
Managing Startup Stock Warrants with Capboard
Managing stock warrants may be overwhelming but it does not have to be. Whether you are planning to issue warrants to potential investors or already have warrant holders in your startup, you organize it all with Capboard.
Easily add and manage warrants, allow investors to exercise their rights, issue and add shares with ease to your cap table. Create an account to find out how startup founders take care of their warrants without having to worry about tons of documents and spreadsheets.