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Issuing Warrants
to Investors |
by:
Dave Lavinsky |
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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