What Is an Equity Warrant?

Jim B.

An equity warrant is an investment option that is attached by companies to lure investors into buying their debt. The company issuing the debt, usually in the form of bonds, will include a document, or warrant, giving the investor holding it the opportunity to purchase equity in the company at some later date. In this way, an equity warrant acts in the much the same way as a stock option, with the difference being that it comes from the company itself rather than from investment brokers or other traders. If the investor exercises this option to buy equity, it does not excuse the issuing company from its debt obligations.

Man climbing a rope
Man climbing a rope

Companies needing funds to either maintain operations or engage in some sort of new business initiative have several options open to them. One way to raise funds is to issue debt to investors. Investors will purchase this debt, usually in the form of corporate bonds, knowing that they will receive a return on their investment in the form of interest payments. Those companies wanting to sweeten the deal for investors might also choose to include an equity warrant.

If investors purchase a bond that contains an equity warrant, they have the right to purchase stock from that company at a specific price at some point in the future, though they are not obligated to do so. This option becomes valuable if the price of the stock goes up in the future. When that occurs, the investor holding a warrant can buy the shares at the lower predetermined price, sell the shares for the higher current market price, and pocket the difference. He or she could also hold onto the stock and hopes that it continues to rise in value.

In most cases, an equity warrant comes with a date at which the option becomes void. This date is generally years after the bond is purchased, giving investors much more time than in typical stock options, which usually expire in a matter of months. Investors might also choose to sell the option on the secondary market and gain benefit from it in that manner.

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It is important to realize that the equity warrant, even if it is exercised, does not replace the debt obligations placed upon the issuing company. The fact that the investor can cash in on the stock and still receive bond interest as well as the return of his or her initial bond investment is what makes this warrant so valuable. This arrangement can also be beneficial to the companies, which can receive capital twice from investors if the stock option is exercised.

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