Warrant Coverage

Warrant Coverage: Definition and Overview

Warrant coverage is an agreement that gives an investor the right to purchase additional shares of a company at a specified price, usually tied to an investment or financing round. The company issues warrants equal to a percentage of the dollar amount invested (for example, 10% warrant coverage on a $1,000,000 investment equals $100,000 in warrants). Warrants increase an investor’s potential upside if the company’s value rises.

How Warrant Coverage Works

• When an investor provides capital (equity or debt), the company grants warrants as a sweetener.
• A warrant grants the holder the right — but not the obligation — to buy shares at a predetermined exercise (strike) price before or at maturity.
• If the holder exercises the warrant, the company issues new shares and receives the exercise price in cash.
• Because new shares are created, exercise of warrants dilutes existing shareholders’ ownership.

How Warrants Differ from Options

• Origin: Warrants are issued by the company itself; options typically trade between investors.
• Dilution: Exercised warrants lead the company to issue new shares, diluting existing equity. Options often transfer existing shares.
• Attachments: Warrants are often issued alongside other securities (e.g., bonds, convertible notes) to make those instruments more attractive.

Why Companies Issue Warrants

Companies use warrants to:
* Attract capital when other financing terms are unattractive.
* Lower immediate cash costs of borrowing by attaching warrants to bonds or notes.
* Make financing deals more appealing to investors by offering future upside participation.

Benefits and Drawbacks for Investors

Benefits:
* Upside participation if the company’s share price rises above the exercise price.
* Potential protection against dilution from future share offerings (indirectly, by increasing the investor’s total share count).

Drawbacks:
* No additional downside protection — if the company performs poorly, warrants may expire worthless.
* Exercising warrants is dilutive to existing shareholders (including the investor who exercises them, relative to the total outstanding shares after exercise).

Example

An investor buys 1,000,000 shares at $5 each ($5,000,000 total). The company grants 20% warrant coverage, meaning $1,000,000 in warrants — technically 200,000 warrants exercisable at $5 each. If the company later trades above $5, the investor can exercise the warrants to acquire those additional shares and benefit from the appreciation. If the share price remains below $5, the warrants likely expire worthless.

Warrant Coverage on Convertible Notes and “10% Warrant”

• On a convertible note, warrant coverage entitles the lender to purchase additional shares based on a percentage of the loan principal.
• A “10% warrant” on a $1,000,000 loan means $100,000 worth of warrants (the company guarantees warrants with a face value equal to 10% of the principal).

Key Takeaways

• Warrant coverage enhances investor upside by granting rights to buy future shares at a set price.
• Warrants are issued by companies, are generally dilutive, and are often attached to other securities to attract investors.
• They offer potential gains without providing downside protection; their value depends on future share-price appreciation.