Updated July 7, 2023
Definition of Stock Warrant
The company grants investors an option to purchase its stock at a predetermined price within a fixed period through a stock warrant contract, which renders the option worthless upon expiration of the period.
The investors are free to deny the purchase of underlying security.
Explanation
The stock warrant is a right (not an obligation) the company gives its investors to purchase its share at a specific price within a given period. It 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, the holder is not obligated 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 designates the holder’s ability to purchase the shares at a specified rate, referred to 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 company can issue the stock warrant directly to the investor, or the investor can purchase it from the secondary market where they trade like any other security. It does not require any particular kind of account.
Accounting for Stock Warrants
The process involves totaling up the prevailing market value of the purchased stock warrant and the security at the time of issuance. Then, we calculate the respective percentage for each of them. Next, we allocate the original issue price into the proceeds, distributing them to 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.
Advantages
- It is freely transferrable by just transferring the document; 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.
Disadvantages
- The companies listed on the stock exchange can only issue the stock warranted.
- 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 on issuing 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, the investor has to bear the loss of the amount.
Conclusion
Thus, a stock warrant refers to the option granted by the companies to the investors to purchase the company shares 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.
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This is a guide to Stock Warrant. Here we also discuss the definition, types of stock warrants, and their advantages and disadvantages. You may also have a look at the following articles to learn more –
