Share warrants are among the different types of financial instruments that companies issue. Here is everything that you need to know about the concept, from the meaning of share warrants and how they work to the different types of warrants that are commonly issued.
What is a share warrant
A share warrant in finance is an instrument that gives the holder the right to purchase or sell the issuing company’s shares at a set price. The transaction should occur on a predetermined date or within a particular period. However, it is important to note that the share warrant only gives the holder the right and not the obligation to purchase or sell the shares.
This means that the holder may choose not to exercise the warrant offered to them. In that case, the warrant would lapse automatically. Alternatively, holders who do not wish to exercise their warrants may choose to sell them to other investors on the secondary market or through the over-the-counter (OTC) market.
What are the different types of share warrants
Share warrants can be classified into two major types: call and put warrants. Let us explore each of them in more detail.
- Call warrants
A call warrant gives the holder the right to purchase the issuing company’s shares at the specified price on a predetermined future date (or within a certain period).
The ideal time to exercise a call warrant is when the company's share price is above the price mentioned on the instrument. However, if the company's share price is below the price mentioned on the warrant, exercising it would lead to a loss. - Put warrants
A put warrant gives the holder the right to sell the issuing company’s shares at the specified price on a predetermined future date (or within a certain period).
The ideal time to exercise a put warrant is when the company's share price is below the price mentioned on the instrument. You will incur a loss if you exercise the warrant when the share price is above the price mentioned.
How do share warrants work
Here is an example to help you understand how a typical call share warrant works.
Assume you hold 100 shares of ABC limited. The company issues call warrants for free to all of its existing shareholders, giving them the right to purchase an equivalent number of shares they hold.
As per the share warrant, you are entitled to purchase 100 shares of ABC limited at Rs. 2,130 per share within six months from the date of issue. Now, exercising the call warrant would only be beneficial if the market price of ABC limited’s shares is above Rs. 2,130 per share. If it is below this price, you will incur a loss since you would have paid more than what the share is worth on the market.
In the example, the warrant can be exercised anytime in the next six months. So, you could wait until the share price rises above Rs. 2,130 per share before exercising the instrument. This will allow you to purchase the company’s shares at a price lower than what they are worth on the market.
On the other hand, if you do not wish to exercise your warrant, you could either sell it to another investor through the secondary market or simply let the warrant expire worthless.
Why do companies issue warrants
Companies generally issue share warrants for two primary reasons. Here is a closer look at each of the two reasons.
- For raising capital
Companies that need funds to expand or grow their businesses may choose to issue share warrants to their existing shareholders. This is a much easier way to get access to capital compared to raising funds through a public issue, which has more stringent regulatory requirements. In addition to being more convenient, raising funds through a share warrant issue is also more economical. - To attract or retain talent
A company may also issue share warrants as an incentive to attract highly talented employees. Offering shares that can be purchased at a future date could provide the entity an edge over its peers when hiring talent. Alternatively, the company could also offer share warrants to existing employees as an incentive for their contribution to the company's growth or to motivate them further.
Conclusion
Share warrants are unique financial instruments that enable companies to raise funds from their existing shareholders. Compared to public issues, share warrants provide an easier, and more cost-effective way to gain access to capital. Share warrants are also beneficial to the existing shareholders since they can purchase more shares of the company at attractive prices.
Although many companies issued them before the Companies Act of 2013 came into force, the practice has since dwindled. However, if you are an investor with a warrant, remember to exercise them at the right time. Exercising a warrant when the stock price is unfavourable to you could lead to a loss. Alternatively, if you do not plan on exercising your warrant, consider selling it on the secondary market instead of letting it lapse so you can benefit from the instrument.
