Issuing Warrants to Investors

When raising capital for a business venture, warrants are a common form of shares given to the investors. A warrant is an option - it gives the holder the right to buy at a fixed or formulaic price, known as the "exercise" or "strike" price an effect.

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 usually issued to employees to investors. Conversely, warrants act as short-term options and, unlike employee options, can be traded as an independent security.

In general, nor 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, when a bondholder with warrants issued as a package, original issue discount problems are invited.

One type of warrant that once popular as a funding mechanism for emerging ventures is contingent warrants. These warrants may be exercised 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 costs for the issuer.

As an option, a warrant is a "common stock equivalent" for accounting purposes. And, if the warrant is "in the money" (ie, the exercise price is lower than the market price) for three consecutive months, shall be deemed to affect the earnings per share under the so-called treasury stock method. That is, the warrants are considered exercised, new stock issued at the exercise price and the proceeds to the issuer are used to buy stock at the market price.

Warrants are a common financing mechanism and companies seeking venture capital should consider and be informed of such shares device.

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