Startups often issue warrants stock to raise capital. They can be issued with other securities like bonds or preferred stock, or they can be offered separately. It’s similar to a stock option in many aspects, but both have significant differences.
When you hold a warrants stock, you can purchase the underlying stock at a specific price, known as the exercise price or strike price.
Read on to learn everything you should know about a stock warrant and its benefits to startups and investors, including how to exercise a stock warrant.
Stock warrant meaning
A stock warrant grants the holder the right, but not the obligation, to purchase a specified number of shares of a startup's stock at a predetermined price within a specific timeframe. It is essentially a contract between the issuer of the warrant and the holder. Startups issue stock warrants as part of a financing arrangement or as an incentive to attract investors.
The key feature of a stock warrant is its potential for capital appreciation. By holding a warrant, investors can gain profit if the underlying stock price increases beyond the predetermined price or the stock warrant strike price. If the stock price exceeds the strike price during the warrant's validity period, holders can exercise stock warrants and purchase the shares at a lower price to realize the gain.
How do stock warrants work?
Stock warrants can provide investors with the potential for higher returns compared to simply owning the stock. Since the warrant allows you to buy the stock at a predetermined price, it can be advantageous if the market price of the stock increases significantly.
If the stock price rises above the exercise price, the warrant becomes valuable because you can buy the stock at a lower price and potentially sell it for a profit. This price is set when the warrant is issued and remains fixed throughout its lifespan, even if the market value of the stock changes.
However, it's crucial to note that stock warrants also come with risks. If the stock price doesn't surpass the exercise price during the warrant's lifespan, the warrant may expire without a profit, and you could lose your investment. Stock warrants expire, after which they become invalid.
So, timing is vital when it comes to making use of stock warrants. You should also take into account the taxation of stock warrants and any restrictions outlined in the warrant agreement.
How do you exercise a stock warrant?
Exercising stock warrants is the process by which the holders of the warrants exercise their right to purchase the underlying shares of a startup at a predetermined price. The exercise of a warrant involves the following steps:
- Understanding the terms: Inspect the warrant agreement to know the exercise price, expiration date, and the number of shares you can purchase.
- Contacting your broker: Reach out to your broker or the startup that issued the warrant to kickstart the exercise process.
- Completing necessary forms: Fill out the required paperwork, which usually includes a warrant exercise notice. Provide your details, the number of shares you want to purchase, and any payment information.
- Arranging payments: Ensure you have the funds ready to complete the transaction. Cash payment is required in most transactions, but check if alternatives like cashless exercises or using certain securities are available.
- Submitting exercise notice and payment: Send in your exercise notice and make the payment as instructed. Double-check that all the information is accurate.
- Awaiting processing: The startup or its transfer agent will process your exercise request. It might take a few business days.
- Receiving the shares: Once your exercise is approved and processed, you'll receive the corresponding shares of stock in your brokerage account.
Stock warrants vs stock options
The difference between stock options and warrants is that stock warrants are issued directly by the startup and are often traded over the counter. Warrants often have a longer lifespan compared to options, ranging from a few months to several years (some can last up to 15 yrs). A longer period gives investors more time to benefit from potential stock price movements. Stock options can exist for one or two months to three years.
The exercise price of a stock option is usually the current market price of the stock at the time of the grant, while the exercise price of a stock warrant is predetermined and set at a higher price than the market price at the time of issuance.
Stock options are usually non-transferable and can only be exercised by the original grantee, while warrants stocks are transferable and can be bought and sold on the open market like stocks. For investors, stock warrants can be an attractive investment vehicle, as they offer the potential for higher returns compared to investing in the underlying stock directly.
Can you sell a stock warrant?
Yes, you can sell stock warrants in the open market. Once you own a stock warrant, you can sell it to another investor before it expires. Selling a stock warrant can be done through brokerage accounts or other platforms that facilitate the buying and selling of securities.
The selling price of a stock warrant will depend on various factors, including the underlying stock price, time remaining until expiration, and market demand. Selling a stock warrant allows the investor to profit from any increase in its value without exercising the warrant and purchasing the underlying stock. It provides flexibility and an opportunity to capitalize on market conditions or changes in personal investment strategies.
Stock warrant: Key takeaways
A stock warrant enables investors to purchase a startup's stock at a predetermined price within a specific timeframe. Buying a stock warrant can be a lucrative investment if the stock price rises above the exercise price, but can also carry the risk of stock warrant expiration if the stock fails to reach that threshold.
If you're considering investing in stock warrants, it's always a good idea to do your research, understand the terms and conditions, and consult with a financial advisor to make informed decisions.
Disclaimer: LTSE is neither a law firm nor provides legal advice. Before making decisions on matters covered by this post, readers should consult their legal adviser.