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Issuing
Warrants to Investors
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by: Dave
Lavinsky
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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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