Warrant agreement: Overview, definition, and example
What is a warrant agreement?
A warrant agreement is a contract between a company and an investor (or holder) that grants the holder the right, but not the obligation, to purchase a specific number of shares of the company’s stock at a predetermined price (the "exercise price") within a certain period of time. Warrants are often issued as part of a larger financing package, such as in conjunction with bonds or preferred stock offerings, as an incentive for investors. The agreement outlines the terms of the warrant, including the exercise price, expiration date, and any adjustments to the terms, such as anti-dilution provisions.
For example, a company may issue warrants that allow an investor to buy 100,000 shares of the company’s stock at $10 per share, with the right to exercise the warrant over the next 5 years.
Why is a warrant agreement important?
A warrant agreement is important because it provides an opportunity for investors to potentially profit from the future increase in the value of a company’s stock. By offering warrants, companies can raise capital or incentivize investors to participate in a financing round, especially in cases where the company is not yet ready for an equity offering. For investors, warrants represent a leverage opportunity; if the company's stock price rises above the exercise price, they can buy shares at a discount.
For businesses, a warrant agreement can be an effective tool to attract investment or offer existing shareholders an opportunity to benefit from future growth without immediately diluting ownership or incurring additional debt. For investors, the agreement offers flexibility and potential upside if the company performs well.
Understanding a warrant agreement through an example
Imagine a startup that issues a series of convertible bonds to raise capital. As an added incentive, the company also issues detachable warrants as part of the agreement. The warrant agreement specifies that each bondholder will receive one warrant for every bond purchased, with the right to buy 100 shares of common stock at an exercise price of $20 per share, exercisable within five years from the date of issuance.
If, over the course of the next few years, the company's stock price rises to $50 per share, the bondholders can exercise their warrants, buying shares at the agreed-upon price of $20, thus realizing a significant profit. If the stock price does not rise above the exercise price, the bondholders can simply choose not to exercise the warrants.
In another example, a company issues warrants to an investor in a private equity round. The warrants give the investor the right to purchase 10,000 shares of stock at $15 per share within the next 3 years. If the company grows and the stock price reaches $30 per share, the investor can exercise the warrants and profit from the difference.
An example of a warrant agreement clause
Here’s how a warrant agreement clause might appear in a financing or investment agreement:
“The Company hereby grants to the Holder the right to purchase, at an exercise price of $10 per share, a total of 50,000 shares of the Company’s common stock, subject to adjustment as provided herein. This Warrant may be exercised in whole or in part at any time before the expiration date of [insert expiration date]. The Warrant is transferable, subject to the terms of this Agreement, and may be exercised by the Holder or its transferee by providing written notice to the Company and payment of the exercise price.”
Conclusion
A warrant agreement is a financial instrument that grants investors the right to purchase company shares at a predetermined price, offering potential upside if the company’s stock value increases. It provides a flexible financing tool for companies and a leveraged investment opportunity for investors.For businesses, warrant agreements can help raise capital or incentivize investment without immediately diluting equity. For investors, the ability to purchase shares at a future date at a fixed price presents an opportunity to benefit from a company’s growth.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.