Cap table

Warrants – Everything You Need to Know

November 25, 20202992 views0

Warrants are instruments that give holders the right to buy a particular stock at a predetermined price within a given time frame.

To gain this right, the holders usually need to make at least some upfront investment in the startup; the warrants then become “sweeteners” for angels or institutional investors or strategic investors. Warrants allow investors to increase their stake in the venture if the performance of the business is on a high growth path. What is important to note is that these instruments give the buyer the right to buy the underlying security at a predetermined price (exercise price) on or before a predetermined date (expiry). Still, the buyer is not under any obligation to buy the security if they wish not to.

As noted in this Forbes blog – In the case of early-stage investments or angel deals, warrants are offered as an incentive to invest – a mechanism that will allow an investor to increase their position in the future for today’s price. If the company is doing, the investor may cash in further, and if the startup fails, he needn’t exercise the warrant.

A recent example is Bennett Coleman and Company Ltd (BCCL), picking up an equity stake in Bengaluru-based cloud kitchen startup Rebel Foods in February 2020. As per this article in Inc42, the company converted BCCL’s five-share warrants from 2017 into 714 equity shares worth INR 16.25 cr ($2.2 M). The issue has been made at a nominal value of INR 10 with a premium of INR 2.27 lakh.

It is important to know that warrants do not pay dividends or come with voting rights. It is only after they are converted into equity shares that the investor gains dividends and voting rights. So why are investors attracted to warrants? Because warrants serve as a means of leveraging their position at a later date.

Difference between Warrants and ESOPs

	Warrants	ESOPs
Nature	Given to subscribe to equity shares	Compensatory in nature
Eligibility	Issued to anyone	Issued only to eligible employees
Upfront Payment	Required	None
Forfeiture of Payment	Option premium may be forfeited	Payments made by employees can’t be forfeited

Difference between Warrants and CCDs

	Warrants	CCDs
Nature	Option to convert lies with the shareholder	Compulsorily converted into equity
Conversion	Will expire if options are not exercised in time	Will convert to equity
Interest	No payment of interest	Interest might be paid
Liquidation Preference	Depends on the term of issue, if liquidation occurs before conversion	Always preferred

Difference between Warrants and CCPs

	Warrants	CCPS
Nature	Option to convert lies with the shareholder	Compulsorily converted into equity
Share Capital	Not a part of share pool capital	Part of share pool capital
Liquidation Preference	Depends on the term of issue, if liquidation occurs before conversion	Always preferred

Conditions for issuing warrants under SEBI(ICDR) Regulations, 2009

Regulation 4(3) of SEBI (ICDR) Regulations, 2009 permits issue subject to the following conditions:

Tenure not to exceed 18 months from the date of allotment
Not more than one warrant shall be attached to one specified security
The price or conversion formula of the warrants shall be determined upfront
At least 25% of the consideration amount shall be received upfront
In case the option is not exercised by the holder, the issuer shall forfeit the consideration paid in respect of such warrant

Regulation 77 (2) of SEBI(ICDR)Regulations, 2009 mandates that an amount equivalent to

25% of the consideration determined in terms of regulation 76 is to be paid against each warrant on the date of allotment of warrants
The balance of the consideration shall be paid at the time of allotment of equity shares pursuant to exercise of option against each such warrant by the warrant holder

Disclosure of Warrants in Balance Sheets

Money received against share warrants are disclosed separately in the balance sheet under ‘Shareholder funds’ on the liability side and does not form part of paid-up share capital unless converted into shares.
In case of warrants issued at a premium, the amount of share premium received will form a part of the securities premium account.
The amount of option premium received will form part of the profit and loss account if the amount is not forfeited.
The amount of option premium received will form part of the capital reserve if the amount is forfeited.

Schedule a demo now!