27 Apr Raising Capital with Investor Warrants in a Public Offering
One of the largest needs in the market is access to capital. It’s one of the biggest reasons companies go public in the first place. In fact, during the lifecycle of all businesses, at some point, access to capital becomes a life or death necessity. When it comes to using a public offering for raising money, there are some key structural components that can be used to ensure both investors and the company benefits from the public offering. One of the best-kept secrets for doing this is through the issuance of investor warrants.
What is a Warrant?
A warrant is a simple contract between the investor and the company, giving the investor the ability to purchase a specific amount of additional shares in the company at some future date and on specific terms. Warrants can be structured very differently and in various ways, but when it comes to raising capital through additional investor cash inflow, a warrant is typically an option to buy at a particular price at some point after the public offering takes place.
Investors are incentivized to buy more stock if the stock runs up in price because there is a protected opportunity for arbitrage. For instance, if an investor has a warrant option to purchase the company’s stock at $5 and the stock is currently trading at $15, then the investor can buy simply at $5 and immediately sell at $15, for a total net of $10 per share. It’s a way to immediately profit and it gives investors the ability to share more in the upside. This is helpful as an incentive to get investors to share in the risk/reward of a company’s success.
How is the Money Raised?
The best way to paint a good picture on how money is raised through a public offering using investor warrants is to paint a real life example of a creatively-structured deal using this unique contract.
In a typical microcap/reverse merger deal, a number of small investors would purchase a few thousand shares at between $0.10 and $0.25 per share. Each share would include four to five warrants at somewhere around $0.50. This means that for each share of stock originally purchased by the investor, they might have the right to purchase another five shares at the warrant price of $0.50 once the stock reaches the $0.50 threshold.
Let’s get a bit more specific. Let’s say for simplicity, we have 100 investors each of whom purchase an initial 50,000 shares at $0.20 each. Each initial share has five warrants at $0.50. This means that for each of the initial 50,000 shares, another 250,000 shares can be purchased at $0.50 at some point in the future. For simplicity’s sake, let’s say all of the 100 investors determine to exercise their warrants when the stock price reaches $1. When this occurs, $0.50 of each warrant flows to the company as a “capital raise,” while the other $0.50 of the $1 is given to the investor as the warrant arbitrage.
Capital Flowing to the Company: 100 investors x 250,000 shares x $0.50 per share = $12,500,000
Capital Flowing to Investors: 250,000 shares x $0.50 per share = $125,000
Assuming the investors also sold their original 50,000 shares at $1, then their total return would equal $175,000.
This $175,000 returned to investors came from an original investment of $10,000 (50,000 shares x $0.20 per share). That’s a 17.5x return in a very short period of time.
While this is a fictitious example, it helps to paint a picture of how investor warrants can be used to effectively raise capital in a public offering. This example also assumes a fairly large amount of public float, especially for a small/microcap company.
Because so many of the moving parts here are reliant on one another, there are no guarantees on how well an offering with warrants will shake-out. One can only prepare and structure properly, hoping that the legal promotion of the offering will result in enough financing to sustain the business in it’s growth plans. The ultimate success of the warrant depends on the structure of the deal, the success of a promotion campaign and the price the stock reaches before each investor intends to exercise his/her warrants.
Warrants work well for companies with high or expectedly high growth, but the future solidity of the company may yet be uncertain. By purchasing at a low basis before the public offering, pre-ipo investors are able to not only mitigate investment risk, but they are able to invest further based on the success of the company’s stock compared to their own warrant price. Investors often love warrants as it gives them the ability to participate further in the event that the stock performs well in the public offering.