Why does a company issue stock warrants? Why not just issue stock, and if necessary, bonds? Understanding why a company has issued warrants, and to whom, is a very valuable piece of information on which savvy traders can make decisions.
If the shares are issued to insiders or mainly to a loyal investor, there is a decent change the warrant terms will change should the warrants be approaching their expiration date and be out of the money. Often the issuing company will extend the expiration date for the warrants and on occasion they may even lower the exercise price.
They may also issue new warrants to replace the expiring ones. Conversely, if the warrants are held by the general public it is more likely that out of the money warrants will be allowed to expire worthless.
Issuing Stock Warrants as Part of an IPO
Most companies do not have to issue warrants when they perform an initial public offering (IPO). But, for small companies initiating an IPO, warrants can serve as a carrot to get more investors onboard, and raise more money for the company than through stock issuance alone.
Let’s use an example. Company XYZ can safely issue 1 million shares of stock at a price of $10 per share raising $10 million. They have determined this is the maximum amount their offering can raise, and they don’t want to issue more than 1 million shares initially.
But suppose Company XYZ knows other investors who are willing to put another $500,000 into the company but do not want to pay $10 per share. These investors only want to pay $5 per share. How can Company XYZ get the $500,000 from these potential investors? You guessed it, issue warrants along with their common.
Company XYZ can issue 100,000 warrants at $5. They will set the exercise price at $5 also, so 1 warrant plus $5 can be exercised for 1 share of common stock. The warrant buyers only risk $5 per share, XYZ gets the extra $500,000, and Company XYZ stands to bring in another $500,000 if the warrants are eventually exercised.
Most often this is done by a small company with somewhat questionable prospects, but a company which investors are willing to invest in at a certain price. It is a balance between setting the right price to lure investors and not giving away more of the company than is necessary to outside investors.
Issuing Stock Warrants as Part of a Court Settlement
On occasion a court will order a company to compensate a class that has brought an action against a company. The restitution can take various forms, cash, a coupon, and in some cases stock warrants.
A company can negotiate the settlement to include warrants as part of the settlement. Warrants, as options, are leveraged instruments and therefore offer more upside should the company (and specifically the stock of the company) do well.
This gives the party receiving the warrants the opportunity to benefit from a leveraged instrument. These warrants are normally deep in the money when issued, which lessens the risk that they will move out of the money and expire worthless.
Issuing Stock Warrants as Part of Negotiated Agreement
Stock warrants can also be issued as part of a negotiated agreement between the company issuing the warrants and another party. One example of this type of issuance is a company that issues warrants to a union in exchange for concessions or in lieu of benefits for union members.
Issuing Stock Warrants as Part of a Government Relief Program
Most investors who are familiar with warrants are familiar with them because of their frequent use in the government bailouts during the financial crisis in 2008-2010. Several large public companies that would not normally issue warrants were forced to issue warrants to the U.S. Government in exchange for capital during the crisis.
Well known companies such as AIG, Bank of America, and Citigroup all issued warrants as part of the government bailout. These shares were originally issued to the government and then subsequently listed for public trading as the government sold shares through public offerings.