Warrant Coverage: What it is, Examples, and FAQs

What Is Warrant Coverage?

Warrant coverage is an agreement between a company and shareholders where the company issues a warrant equal to a percentage of the investment. Warrants, like options, allow investors to acquire shares at a designated price.

Warrant coverage agreements sweeten the deal for investors by leveraging their investment and increasing their return if the company’s value increases.

Key Takeaways

• Warrant coverage gives shareholders the opportunity to gain additional shares.
• An agreement is made for the investor to be issued warrants.
• Warrants function similar to options and dilute equity ownership.

Understanding Warrant Coverage

Warrant coverage assures investors that they can increase their share of ownership in the company if circumstances rapidly improve. This is done by issuing warrants as a condition of the investors’ participation.

A warrant is a derivative that gives the holder the right to buy the underlying stock at a specified price before or at maturity. The warrant does not obligate the holder to purchase the underlying stock. Warrant coverage is the agreement to issue stocks to cover the future execution of the warrant instrument.

Warrants are similar to options but originate from a company, dilute the underlying stock, and can be attached to other securities, notably bonds.

Reasons for Warrant Coverage

Warrant coverage allows and encourages the holder to participate in the company’s success and protects against the dilutive effects of future share offerings.

Warrants attached to bonds can attract more capital for a company. They are often seen as speculative.

During the financial crisis of 2008, Goldman Sachs issued warrants to raise capital and improve its financial health.

Example of Warrant Coverage

An investor purchases 1,000,000 shares of stock for $5 per share, totaling a $5,000,000 investment. The company grants a 20% warrant coverage and issues $1,000,000 in warrants. The company guarantees 200,000 additional shares at an exercise price of $5 per share.

Issuing warrants does not provide downside protection but gives the investor upside if the company goes public or is sold above $5 per share.

What Is a Warrant Coverage on a Convertible Note?

On a convertible note, warrant coverage allows the holder to purchase additional shares based on the loan principal.

What Is a 10% Warrant?

Warrant coverage is a percentage based on the loan principal. A 10% warrant coverage on a $1,000,000 loan equals $100,000 in warrants.

Why Do Companies Issue Warrants?

Companies issue warrants to raise capital. When a company sells a warrant, it receives payment. If stocks are purchased using the warrant later, the company also receives money.