Definition of Stock Warrant
A stock warrant is a kind of contract made between a company and investors where the investor is given an option by the company to purchase its stock at a pre-determined price within a fixed period, and the option becomes worthless as soon as the period gets expires. The investors are free to deny the purchase of underlying security.
The stock warrant is a right (not obligation) given by the company to its investors to purchase its share at a specific price within a given period. The stock warrant does not transfer any ownership of the security to the holder but offers an option to the investor to purchase a share of such a company. Also, there is no obligation on the holder to exercise the opportunity granted by the stock warrant; if the investor exercises the warrant, the amount received from the investor increases the company’s share capital.
Example of Stock Warrant
A company named XY Inc. issues a stock warrant to the investors that gives them the right to purchase 1,000 shares of the company at $50 per share (known as the exercise price) over 15 years. Until the expiration of 15 years, it will be beneficial for the investor to exercise the option if the option’s market price is greater than the exercise price and vice versa.
Types of Stock Warrant
Mostly there are two types of stock warrants that the company mainly issues. They are:
- Call Warrant: A Call warrant gives the right investor to buy a fixed number of company shares within a stipulated time.
- Put Warrant: A put warrant gives a right to the investor to sell the given number of shares to the company at a pre-determined price within a stipulated time.
What’s in Stock Warrant?
The stock warrant consists of the following items:
- The stock warrant’s first element is the total number of shares the holder is entitled to.
- Secondly, the stock warrant specifies the rate at which the holder can purchase the shares, and the rate is known as the exercise price or strike price.
- Then the stock warrant mentions the expiry date of the warrant, which is the date until the option can be exercised.
- The conversion ratio is also specified in the stock warrant, the ratio used to convert the warrants into the underlying shares.
How to Buy Stock Warrant
The stock warrant can be issued directly by the company to the investor. It can also be purchased from the secondary market as they trade like any other security. It does not require any particular kind of account.
Accounting for Stock Warrants
At the time of issuance, the value prevailing at the market of the purchased stock warrant and the security are totaled up, and their respective percentage for each is calculated. The original issue price is bifurcated into the proceeds, which apply to these individuals based on the calculated percentage. The accountant will record the transaction of the security issue and that of the stock purchase warrant. He will debit the cash for the sum received and do the corresponding credit to the Bonds Payable for the sum determined and the value which came for the warrant. Additional Paid capital is credited.
|Particulars||Debit ($)||Credit ($)|
|Cash A/c …Dr||–|
|To Bonds Payable A/c||–|
|To Additional paid Capital A/c||–|
|(To record the issue of bond along with warrant)|
When exercising the warrant, the holder of the warrant purchases the shares of the corresponding company at a price mentioned on the warrant. The accountant records this activity as a stock sale by debiting the cash received and crediting the Common Stock upto the value at par for the said stock, and any amount paid above the stock’s par value; paid-in capital will be credited.
|Particulars||Debit ($)||Credit ($)|
|Cash A/c …Dr||–|
|To Common Stock A/c||–|
|To Paid in capital A/c||–|
|(To record exercising of warrant)|
Why Are Stock Warrants Issued?
Following are the reasons for the company issuing share capital-
- The company can raise additional sources of capital from investors.
- It attracts more investors who benefit from purchasing the shares below the market price on a future date.
- If the holder of the warrant exercises the right, then the liquidity of the company’s stock can boost the market.
- The warrants are often attached to the bonds, making both bonds & shares more attractive to the investor.
Some of the advantages are explained below-
- It is freely transferrable by just transferring the document, and even registration is not required.
- Investors have the right to exercise the option. Therefore, investors will buy the shares only if the exercise price is less than the market price so that the investor can get the shares at a low price.
- The banks even accept share warrants as security against loans.
- For the company, the stock warrant helps raise additional capital.
Some of the disadvantages are explained below-
- The stock warranted can only be issued by the companies listed on the stock exchange.
- The prior approval of the central government is required to be taken before issuing a stock warrant.
- Even the cost of issuing a share warrant is high such as the stamp duty is high on the issuance of a stock warrant.
- Like any other financial instrument, stock warrants are also prone to the risk of the market.
- The holder of the warrant is not a shareholder of the company. Thus, no voting right is given to the instrument holder.
- Some amount is to be paid by the holder upfront to acquire the share warrant, and if the holder does not exercise the option, then the investor has to bear the loss of the amount.
Thus, a stock warrant refers to the option granted by the companies to the investors to purchase the shares of the company at a specific price, known as the exercise price, within a certain period. It is beneficial for the company to raise an additional source of capital and beneficial to the investor to buy the company’s share at a price lower than the market price.
This is a guide to Stock Warrant. Here we also discuss the definition and types of stock warrants along with their advantages and disadvantages. You may also have a look at the following articles to learn more –