What it means
A call warrant has three key terms: the exercise price at which shares can be bought, the number of shares each warrant buys, and the expiry date. Warrants typically run for several years rather than months, which is far longer than a traded option, and they are often attached to a bond or a loan as an added incentive for the lender.
The holder pays nothing more until the warrant is exercised. They matter to a finance team for two reasons: dilution and accounting.
Because exercise creates new shares, warrants must be included in the calculation of diluted earnings per share, and depending on how they are settled they may sit in equity or be treated as a liability that is remeasured each period. Boards that treat warrants as a free sweetener are often surprised by both effects.
The commercial logic is a trade of cash now for ownership later. A lender accepting warrants alongside a loan will usually accept a lower interest rate, because it keeps a share in the upside if the business does well, and a company short of cash gets cheaper borrowing without giving up control today.
The arrangement is common where a business is growing quickly but cannot support a high cash coupon. Valuing a warrant has two parts.
The intrinsic value is simply the share price less the exercise price, multiplied by the number of shares the warrant buys, and never less than zero; on top of that sits time value, which reflects the chance that the share price will rise further before expiry. A warrant with an exercise price above the current share price still has value for that reason.
The distinction from an ordinary traded call option is worth holding onto. A traded option is written by another investor, settles against existing shares and is guaranteed by a clearing house, whereas a warrant is written by the company, creates new shares and carries the company's own credit standing.
The payoff diagram looks the same; the consequences for the share register do not.
In practice
Real-world examples.
Example
A medical device start-up borrows $4,000,000 at 6% rather than 11% by giving the lender warrants over 3% of its shares. The cash saved on interest funds a clinical trial, and the lender shares in the gain if the device is approved.
Example
A listed mining company raises equity in a weak market by selling each new share with a half warrant attached. Investors get a second chance to buy at a fixed price if the commodity price recovers, which makes the original placing possible at all.
Example
A buyer assessing a software company finds 1,200,000 warrants outstanding at an exercise price well below the agreed deal price. The offer is restated on a fully diluted basis, which reduces the price per existing share and becomes one of the main negotiation points.
Formula
Calculation
Intrinsic value per warrant = (share price - exercise price) x shares per warrant, with a floor of zero; dilution = new shares issued / total shares after issue
A company has 10,000,000 shares in issue and has granted 500,000 warrants, each buying one share at an exercise price of $12. The share price is now $20, so the intrinsic value of each warrant is 20 - 12 = $8, and the whole block is worth 500,000 x 8 = $4,000,000 before time value. If all the warrants are exercised the company receives 500,000 x 12 = $6,000,000 of cash and the share count rises to 10,500,000, so the dilution is 500,000 / 10,500,000 = 4.76%. On a profit of $21,000,000, earnings per share fall from 21,000,000 / 10,000,000 = $2.10 to 21,000,000 / 10,500,000 = $2.00, which is the figure the company must disclose as diluted earnings per share.Case study
Seen in the real world.
Verdant Rail Components is an illustrative, fictional engineering business that needed $6,000,000 to equip a new factory but could not service a high interest bill while the plant was being built. Its bank offered a loan at 10.5%, or at 6.5% if the lender also received warrants over 400,000 shares at an exercise price of $15.
The finance director compared the two. The lower rate saved 6,000,000 x 0.04 = $240,000 of interest a year, which over a five year term is $1,200,000 of cash kept in the business during the most difficult period. The cost, if the shares later traded at $25, would be a transfer of value of 400,000 x (25 - 15) = $4,000,000 to the lender, plus dilution of the existing holders.
The board chose the warrant structure and recorded an illustrative conclusion in the minutes: warrants are cheap for a company that fails and expensive for one that succeeds, so the decision is really about how badly the cash is needed now.
Watch out
Common mistakes.
- Treating warrants as a cost-free sweetener, when exercising them transfers real value from existing shareholders to the warrant holder.
- Leaving warrants out of the share count when calculating value per share, which overstates what each existing share is worth.
- Assuming a warrant is worthless because the exercise price is above today's share price, when time value can still make it worth paying for.
Questions
People also ask.
What is the difference between a warrant and a share option granted to staff?
Economically they are similar, but staff options are part of employment reward and follow share-based payment rules, while warrants are usually issued to investors or lenders.
Does the company receive money when a warrant is exercised?
Yes, it receives the exercise price for each new share issued, which is why exercise raises cash at the same time as it dilutes holders.
Are warrants always listed and tradable?
Some are listed and can be bought and sold, while many are private instruments held by one lender or investor until they are exercised or expire.
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