Stock warrants are options issued by a company that trade on an exchange and give investors the right (but not obligation) to buy the company’s stock at a specific price within a stipulated period. When an investor exercises a warrant, they purchase the stock, and these proceeds are a source of capital for the company. However, a warrant does not represent the actual ownership of the stocks but the right to buy the company shares at a particular price in the future. Warrants are not popular in the United States, but they are common in other countries like China.
Types of Warrants
There are two types of warrants: a call warrant and put warrant.
A call warrant is the right to buy a specific number of shares from a company at a certain price in future whereas a put warrant represents the amount of equity that can be sold back to an issuing company at a specific price in the future.
Where an investor exercises the right of a warrant, a warrant certificate is issued, and it has the particulars of the warrant type it represents. The certificate specifies the warrant expiry date and the last day it can be executed.
Why are stock warrants issued?
A company may issue a warrant to attract more investors for an offered bond or stock. As a result, the company may obtain better terms on the bond or stock offering. For example, where the company trades its shares at $100 each, and the warrant is $10 each, more investors will exercise the right of a warrant, even if they do not have enough capital to buy the stocks. The warrant represents a potential source of capital in the future when the company needs to raise additional capital without offering other bonds or stock.
Further, companies can issue warrants as a capitalization option when heading to bankruptcy. Issuing warrants provides the company with a future source of capital. Also, a warrant may be issued as a way of preserving the goodwill from the company shareholders. It will be more easy to convince shareholders to pay $10 per warrant than to purchase additional company shares at $100. However, warrants should be used carefully due to the quick gains or losses that they create.
To learn more about corporate financing, see the following CFI resources.