Fundraising Terms: Warrants

Welcome back to another episode of fundraising terms! 

In this episode, we're discussing a term that you might encounter, especially in later-stage financing, Warrants.

So, what are warrants exactly? Well, they're like tickets that give investors the right to buy a set number of shares at a predetermined price within a specific timeframe. It's like having a backstage pass to purchase shares regardless of the stock's current worth. 

Let's check out an example: A 10-year warrant for 100,000 shares of Series A stock at a measly $1 per share gives the warrant holder the option to buy 100,000 shares of Series A stock at $1 per share anytime over the next decade, even if the stock price skyrockets. Talk about a golden opportunity.  We call that "exercising the warrant" – no gym membership required!

Here's another scenario. Say an investor buys 1,000,000 shares at $5 per share, totaling a cool $5,000,000 investment. The company sweetens the deal with a 20% 5-year warrant coverage and issues to the investor $1,000,000 in warrants. In technical terms, this guarantees an extra 200,000 shares at the same $5 per share price for the next 5 years.

In term sheets, it might look a little like this:

Warrant: The Company grants a warrant (a "Warrant") to purchase, for the purchase price of $[Price] per share (the "Exercise Price"), up to [Number] shares of the Company's common stock, par value $[Par Value], at any time during the [Term] period (the "Warrant Period").

The Big Questions 

When should you consider accepting warrants?

lYou can accept warrants from an investor willing to take a disproportionate and quantifiable risk compared to other investors.

Imagine an investor who fearlessly dives into an investment opportunity at a specific price, defying the cautionary whispers of fellow investors. They do so either to prevent a down round or to protect the founders from excessive dilution. This investor assumes a remarkable risk that no one else dares to, deserving the chance to enjoy potential rewards through warrants.

Another scenario is when an investor invests at a time when no other investors dare to venture forth, helping the business to stay alive or propelling it towards a crucial milestone before the next major funding round. This investor may request warrants as a token of their disproportionate risk-taking.

When shouldn’t you accept warrants?

Our recommendation is to avoid warrants if the investor is not taking any quantifiable risks or delivering consequential value to the business in a way that no other investor will be able to bring to the table. This can create a whirlwind of complexity and accounting headaches down the road.

Remember, warrants dilute the existing shareholders' stake in the company. When a warrant holder exercises their superpower, the company issues fresh shares instead of using existing ones.

Warrants don't offer any additional downside protection for the investor. They'll get the shares at the same price they paid, but if your company hits the jackpot and exits at a higher price, they'll benefit from that extra upside.

How should you respond to these warrants?

If it's simply a matter of price, we suggest negotiating for a lower pre-money valuation to try to eliminate the warrants. It'll save you from a wild ride of complications in the future.

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We hope you’ve gained some valuable insights to help you on your fundraising journey. 

See you next time!