I often get questions from CEOs about warrants, so I thought I would share a primer on them here.
A warrant is basically like the options that you give to your employees. It is a contract that enables the holder to buy shares in your company at a fixed price.
Warrants are typically given to investors as an incentive for investing. You see them most often with venture debt rounds. You see them less often as part of an equity round.
A typical venture debt loan might have 10% warrant coverage. In this example, a $5M loan would require you to issue a warrant for $500K worth of shares in your company.
The lender now holds a warrant enabling them to invest $ 500K to buy shares in your company at the price of the most recent financing round. The value for the lender is that they have time to make that decision.
Often the warrant holder has 5 – 7 years to make that decision. In that time, your company will either die (so the warrant is worthless), exit (in which case they exercise and buy the shares) or keep growing (in which case by the time they have to buy your shares your company will be worth a lot more).
These may vary depending on stage and geography, but here’s what I usually see:
- Coverage: 5 – 10%. So for every $100 of investment you will issue $5 – $10 of warrants.
- Term: 5 – 7 years.
- Price: The price of the most recent funding round, or some negotiated price if it has been a long time between rounds.
- Security: The warrants, when exercised, are exchangeable into the most senior security outstanding at the time that the warrant was first granted.
I accept the presence of warrants in debt rounds. But I actively avoid equity deals with warrants. You always want to have clean, simple terms for your equity rounds. If you give warrants to one set of investors, the others may ask for them as well. They are dilutive and are not needed in my humble opinion.
Like stock options, warrants are meant to be a long-term incentive for long-term involvement. As such, one place where you should not give warrants is to investment banker types. They are not involved long term and so should not be walking away with a discounted right to buy shares in your company.