Explanation of why warrants are attractive to a company's investors.
For growth companies involved in the private-placement market, there's a detail of Securities and Exchange Commission policy too sweet to ignore. It hinges on what at first might appear to be a relatively obscure clause in the definition of stock warrants.
Often built into small companies' financing as a way to make an offering more attractive, warrants give stock or bond investors the right to purchase additional securities -- usually common stock -- at a fixed price during a specified time period. Investors love warrants because they offer an extra chance to share in a company's upside potential -- in cases in which the warrant is exercisable at a preset purchase price that turns out to be less than the stock's market value.
"With ordinary warrants, the SEC requires investors who have exercised their warrants to delay selling their stock until expiration of a holding period -- generally two years," notes Rufus King, a partner at Boston law firm Testa, Hurwitz & Thibeault. "However, the agency will waive the holding-period rule for net-issuance warrants."
Here's how those warrants work: "When an investor exercises a net-issuance warrant, no cash actually passes hands," King says. Instead, if the investor is purchasing $5,000 worth of stock at a warrant-conversion price of $2,000, the company subtracts the cost of the conversion and actually turns over only $3,000 worth of shares to its investor.
"Investors like anything that gives them the fastest-possible liquidity, so there's no reason not to include this feature," King says. If you want to make your current shareholders happy, you may even be able to change your pending warrants into net-issuance ones. But be sure to consult your corporate lawyer and your accountant. If the deal is not structured correctly, you could trigger an additional holding period.