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What are Warrants?

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) but the buyer is not under any obligation to buy the security if he or she wishes not to.

As noted in this Forbes blogIn 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 that of 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, nor do they come with voting rights. It is only after warrants are converted into equity shares that the investor gains dividends and voting rights. Why are investors attracted to warrants? This is because these instruments 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 prior to 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 prior to 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 consideration paid in respect of such warrant shall be forfeited by the issuer 

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 in case the amount not forfeited
  • The amount of option premium received will form part of  the capital reserve in case the amount forfeited

 

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