Stock Warrant Purchase Agreements

Stock warrant purchase agreements

Stock Warrant Purchase Agreements

What is a stock warrant?

According to Investopedia, warrants are derivatives that give the right -but not the obligation- to buy or sell a security at a certain price before expiration. The price at which the underlying security is sold is referred to as the exercise price or strike price.

In this sense, a stock warrant gives holders the right to buy a certain amount of company stocks at a fixed price until the expiration date, receiving newly issued stock from the company.

The goal of a stock warrant is to increase the company’s capital while sweetening the deal for potential investors. The appeal is that if the issuer’s stock increases above the warrant’s price, the investor can redeem the warrant, and buy shares at the lower warrant price.

An example of this is a company which issues a bond with warrants attached. The holder gets a $500 face-value bond plus the right to purchase 50 shares of company stock at $10/share within 10 years. The $10/share is the strike price. If the stock rises over $10 within the time period that the warrant is available, this is a good investment opportunity.

Key points about stock warrants

  • A warrant is exercised once the holder tells the issuer they intend to purchase the underlying stock. When a warrant is exercised, the company issues new shares of stock, so the overall number of outstanding shares will increase.
  • The exercise price is fixed shortly after issuance of the bond.
  • A warrant’s premium means how much extra you will need to pay for the shares when purchasing through the warrant, rather than regularly (such as in an exchange or from another investor).
  • You need to take into consideration the conversion ratio. The conversion ratio is the number of warrants that are needed to buy or sell one stock. For example, if the conversion ratio to buy a stock is 5:1, this means the holder needs 5 warrants to purchase one share.
  • Warrants have an expiration date, when the right to exercise no longer exists.

Warrants change depending on where you are. An American-style warrant, for example, allows the holder to exercise at any time before it expires, whereas a European-style warrant requires the holder to keep the warrant and only execute on the expiration date.

Kinds of warrants

Detachable and Non-Detachable

Holders of detachable warrants can sell the warrants without selling the bonds or stock to which they were originally attached. That means that when a warrant is attached to a bond or stock, the holder can sell the warrant but still and keep the bond or stock. This flexibility makes detached warrants much more attractive. This may be especially important when warrants are attached to preferred stock.

Sometimes, investors won’t start receiving dividend payments from preferred stock as long as the stock has an attached warrant. In that case, if the warrants are detachable, holders may want to sell them and just keep the stock. Holders of non-detachable warrants can only sell the warrants when they sell the attached bonds or stock. As a note, these are sometimes also called “wedded” warrants. Non-detachable warrants are issued without any bonds or stocks accompanying them.

Covered Warrants

These are issued by financial institutions, so there are not any new stocks issued when the covered warrants are exercised. The warrants are covered because the institution either owns shares or can acquire them easily.

Call and Put Warrants

A call warrant allows the holder to buy shares from the share issuer. A put warrant allows the holder to sell shares back to the issuer.

The primary difference between a call warrant and a put warrant is that a call warrant will buy a specified number of shares from the company at a future date for a set price. A put warrant is a representation of the equity value that the buyer can sell back to the issuing company in the future for a set price.

Trading Warrants

Exercising a warrant is not the only way to make money with warrants. Investors can also buy and sell warrants.

The minimum value of a warrant is the difference between the current value of the underlying security on the market and the warrant’s strike price. This is the profit that warrant holders will receive if they exercise their warrants at the current time. Warrants that are trading on an exchange, however, may sell for a premium price greater than the minimum value if traders expect the price of the underlying security will rise in the future – just like basic supply and demand and predictions of the market. However, the premium will generally shrink as the expiration date approaches.

Difference between stock warrant and stock options

What is a stock option?

A stock option is a contract in which the holder gets the right -but not the obligation- to buy or sell stock at a specific price, prior to a specific expiration date.

Options are purchased by investors when they expect the price of a stock to go up or down (depending on the option type). For instance, if a stock is worth $40 today, and an investor believes the price will rise to $50 next month, he can purchase a $40 call option today, which would give the investor the right to purchase the stock at that price prior to the expiration date. Then the investor can turn around and sell it for $50 making $10 in profit less the cost of the option, referred as “premium”.

Differences between the two figures

A stock warrant differs from the stock option mainly in two aspects:

  1. A company issues its own warrants, and
  2. The company issues new shares for the transactions

A company may issue a stock warrant if they want to raise additional capital from a stock offering. If a company sells shares at $100 but a warrant is just $10, more investors will exercise the right of a warrant. These are a source of future capital.

Stock options on the other hand are listed on exchanges. When stock options are exchanged, the company itself doesn’t make any money from those transactions.

Also, stock warrants can last up to fifteen years, while stock options usually go for a couple of months to a couple of years at best.

In this sense, for long-term investments, stock warrants may be the way to go, while for short-term investments, stock options have the upper hand.

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What should you include in your Board Member Agreement

Usually, any good Board Member Agreement would include:

  • Services and consideration. In which it would be included the services the 51 percent member (manager) would agree on.
  • Units of the company. How many units have been issued to the manager, what’s the cost of each unit and conditions regarding the possible causes of repurchasing of them.
  • Confidentiality. What constitutes confidential information, limits the manager has using this information and the obligation to return the confidential information the manager possesses to the company in case of termination of the agreement.
  • Ownership of Intangible Property. Determining how the company is going to treat all inventions or creations conceived in whole or in part by the manager that relate in any matter to the business.
  • Return of Company’s Property. The manager’s obligation to return company’s property once its role as board chairman comes to an end.
  • Conflicting Obligations. The obligation of the manager to not engage in any other obligation or agreement that conflicts with the interests of the company.
  • Terms and Termination. Causes for which the board member agreement would terminate.
  • Impossibility of Assignment. Impossibility for the manager of assigning the board member agreement or any other agreement without the consent of the company.

If made right, a good Board Member Agreement would be able to stop any kind of future confrontation thus establishing clear boundaries to corporate owners. If your company doesn’t have a Board Member Agreement yet, you should contact us, so we can work with you and help you figure out what your best options are.  

For a quick assessment of your needs – let’s talk to discuss how Trusts can help your business.

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