Working capital warrants: Overview, definition, and example
What are working capital warrants?
Working capital warrants are financial instruments issued by a company that give the holder the right, but not the obligation, to purchase additional shares of the company’s stock at a specified price within a certain time frame. These warrants are typically issued as part of a financing arrangement, often in conjunction with a loan or equity investment, to provide the company with additional working capital. The holder of the warrant can exercise it to acquire shares, usually at a premium, and the funds raised can help the company meet its operational needs or cover short-term expenses.
Working capital warrants are a way for companies to raise capital without immediately diluting existing shareholders, as the issuance of new shares only occurs when the warrants are exercised.
Why are working capital warrants important?
Working capital warrants are important because they provide companies with a flexible mechanism for raising capital when needed, especially in times of financial strain or when a company requires short-term funding. They allow businesses to secure working capital without issuing immediate equity, thus avoiding immediate dilution of shareholder ownership. For investors or creditors, working capital warrants offer the potential for future returns if the company’s stock price increases, as they can exercise the warrants to purchase shares at a predetermined price.
Working capital warrants are particularly valuable in private equity deals, early-stage financing, or distressed financing scenarios where a company is looking to strengthen its liquidity position.
Understanding working capital warrants through an example
Imagine a tech startup that needs additional working capital to support its operations for the next year. The company issues working capital warrants to investors as part of a financing deal. The warrants give the investors the right to buy shares in the company at $10 per share over the next three years. If the company grows and its stock price rises above $10, the investors can exercise the warrants, purchasing shares at the discounted price and potentially making a profit.
In another example, a company facing liquidity issues may issue working capital warrants to a lender as part of a loan agreement. The lender receives the right to purchase shares of the company at a set price if the company is able to meet certain financial targets. This provides the lender with an additional potential return while offering the company the working capital it needs to continue operations.
An example of a working capital warrants clause
Here’s how a clause related to working capital warrants might appear in a contract or agreement:
"As part of the financing arrangement, the Company agrees to issue working capital warrants to the Lender, entitling the Lender to purchase up to [number] shares of the Company’s common stock at a price of $[price] per share, exercisable within [time period]. The funds raised through the exercise of these warrants will be used exclusively for the Company’s working capital needs."
Conclusion
Working capital warrants are a useful financial tool for companies to raise capital without immediately diluting equity. By issuing warrants, companies can secure the necessary funds to meet short-term operational needs, while providing investors with an opportunity to purchase stock at a later date. These warrants provide flexibility and can be an effective way for companies to manage their cash flow and liquidity, while offering potential upside for investors.
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.