Exercising Stock Warrants
In this article, we will cover everything you need to know regarding stock warrants.
There still exists much mystery around the world of stock warrants and how they different from stock options. While they may be less common than options, they are becoming a useful tool for companies in raising capital and managing their shareholders. These days it’s becoming important to know everything on exercising stock warrants and the tax implications involved.
How do you define stock warrants, and why do companies issue them? This relatively underused derivative has proven a lifeline for companies when managing their shareholdings. Read on to learn more about the most important and distinct features of stock warrants.
What are Stock Warrants?
Stock warrants are basically options that a private company issues. These options trade on an exchange for public companies and provide an investor the right to buy a stock of the company at a particular price within a specific time period. When investors exercise the stock warrant, they buy stock, and the proceeds are a capital source for the organization. That said, a stock warrant does not mean that you get real ownership of these stocks. Instead, you get the right to buy the shares of the company at a certain price in the near future. Stock Warrants are not very common in the US, but they are quite popular in other nations in Asia like China.
The main two types of stock warrants are call and put warrants:
- A call warrant is your right to purchase a particular volume of shares from an organization at a specific price in the near future.
- A put warrant allows you to sell back a particular volume of shares to the company that issued them at a certain price in the near future.
Why do Companies Issue Warrants?
A private company might issue a stock warrant to draw in a greater number of investors for an offered stock or bond. Consequently, the company might procure improved terms on the stock or bond offering. For instance, when the shares of a certain company trade at $100 each, and the stock warrants are $10 each, more investors will exercise the right of a stock warrant. They will do this even if they do not have sufficient capital to purchase the stocks.
The stock warrant represents a potential capital source in the future when the organization requires raising more capital without giving out any other stock or bond. In addition, companies can issue stock warrants as a capitalization alternative when they head towards bankruptcy. Giving out stock warrants offers the company with a future capital source.
Moreover, the company may issue such a warrant as a means of protecting goodwill from the shareholders of the company. It will be far easier to persuade these shareholders to pay $10 for every stock warrant than to buy extra company shares at $100. However, one should utilize stock warrants very carefully owing to the quick losses or gains they create.
Important features of stock warrants
The following are some of the several key features of stock warrants that you ought to be familiar with.
- Expiration Date: All stock warrants come with an expiration date. You can see this date on the contract. Stock warrants provided in the US let the recipient execute the stock warrant any time before and even on the expiration date.
- Pricing Mechanism: An organization will announce a warrant strike after issuing a new bond offering.
- Conversion ratio: This is the number of stock warrants required to sell or purchase a single stock. For instance, if the conversion ratio to purchase a certain stock is 7:1, what this means is that the holder requires seven warrants to buy a single share.
- ‘Heads-Up’ Notice: In all stock warrant deals, every recipient can let the organization know in advance when they will exercise their right to buy the stock. Once the private establishment that offered the stock warrant receives that buying notice, it will issue new shares of stock to enable trading of more shares of its stock. As a result, this will boost the total stock shares of the company, which can lower the stock price.
Now let us look into how stock warrants stack up against stock options.
Stock Warrants vs. Stock Options
Some people often get confused between stock warrants and stock options, and don’t quite understand the differences. There are distinct differences between these two that you should be aware of.
What is the Difference between Stock Warrants and Stock Options?
When it comes to stock warrants vs. stock options, the following are the key differences between the two:
- Organizations issue stock warrants primarily to raise more capital. However, this is not the case with stock options. These stock options are ways via which each investor can place bets on the stock of the company. That said, the organization itself does not generate any cash on each stock-option transaction.
- Stock warrants and stock options have different timetables. The window of investment is wide open for every stock warrant. This particular window can last for as long as a decade and a half in some instances. On the other hand, stock options usually expire in a few months, weeks, or even days. That is precisely why stock market makers are of the opinion that stock options are a superior portfolio strategy (short-term) to stock warrants. Stock experts, conversely, deem stock warrants as a better investment strategy in the long term.
- Stock options and stock warrants have different tax regulations, as well. Taxable ramifications from the usage of stock warrants rely on how you use them. The taxes attached to stock warrants can be quite complex. They are often taxed once the stock warrants are exercised.
- Companies often use stock options to motivate and attract different employees. On the flip side, entities utilize stock warrants to draw in potential investors. They get the stock warrants as a special bonus when they lend cash to the organization or buy its stock that the company has newly issued.
Exercise Stock Warrants
Now we will talk about the backbone of this article- exercising stock warrants. First, you need to comprehend what is an exercise of stock warrants. Once you get a general idea, you need to know how to exercise stock warrants.
What is an Exercise of Stock Warrants?
So what is the meaning of exercising stock warrants? When a certain investor exercises a stock warrant, they buy stock, and the proceeds are a capital source for the organization. The investor receives a stock warrant certificate when they exercise a stock warrant. The certificate features the exact terms of the stock warrant, like the final day the investor can exercise it and the expiry date.
How do I Exercise Stock Warrants?
Are you wondering how you should exercise stock warrants? Holder of a stock warrant might select to exercise the said warrant if the existing price of the stock is more than the warrant’s strike price.
If the existing price of the stock is lower than the strike price, it does not make too much sense to exercise the option. That is because it is more economical to purchase stock on the market.
Let us take an example to understand this better. For instance, a stock warrant’s strike is $30, and the stock is currently trading at $20. In this case, it is not wise to exercise the right to purchase stock at $30 when you can purchase it at $20.
On the flip side, if the stock is currently trading at $40, and the stock warrant’s strike is $30, it is actually advantageous to exercise the stock warrant. However, simply because the existing price of the stock is more than the strike price does not mean it is necessary to exercise the warrant. If there is adequate time until the stock warrant expires, clinging to the warrant might be even more profitable!
As a case to point, if over the next couple of months, the stock climbs to $70, the stock warrant has become more invaluable. The stock is trading on the market at $70, and the holder of the warrant has the right to purchase at $40 (and can instantly sell these shares for $70).
Possibly, the easiest means to exercise a stock warrant is via your broker. The broker will take care of most of the required paperwork and communication with the organization that provided the stock warrant to you. These stock warrants appear in your trading account, similar to an option or stock. Reach out to your broker and let them know that you want to exercise the stock warrants in your account.
Specify just how many, from the total number of stock warrants you are holding, you want to exercise. Once the broker has reached out to the issuing company, the exercised stock warrants will shift from the trading account, and the stock will show up. Keep in mind that your broker is most like to charge you some fee for this particular service.
In case of a private firm, you will need to inform the company when you would like to exercise your warrants, and keep in touch with them about the details of this exercise. As each company handles their stock warrants in a different way, its best to note all the details of the warrant from the first day, in order to follow up accordingly.
Taxation of Exercising Stock Warrants
Although the organization incurs no tax implications for issuing the stock warrants, there are several tax consequences for transferring, holding, exercising, and selling the warrants. It is of paramount importance that you are familiar with these tax implications so that you do not run into any unpleasant financial consequences later on.
Exercising Stock Warrant Options
Holders of stock who exercise rights to buy the stock of the company are legally responsible for the tax on the salary they get from their particular acquisitions. The IRS Tax Code specifies the stock of a company as a certain property for which the owners have to give tax on any money they derive from it. The discrepancy between the price of the stock warrant and the stock’s standard market value that the holder gets on exercising the stock warrant is taxable income. Furthermore, the tax liability is determined on the grounds of that value.
Taxing Losses and Gains
A stock warrant that a company issues can also draw tax liability. Here, the holder of the warrant exercises it during the time specified in the stock warrant certificate, and the price of stock appreciates or depreciates in that particular time. Stock warrant holders should exercise their respective options prior to the warrant period expiration. That is because the stock warrant is not property in itself. The holder of the warrant can opt to keep the stock until the redeeming period. In this scenario, the discrepancy between the market price and the stock’s value at the exercising time might be a capital gain or loss. These gains are taxable in the year you receive them as salary, and losses might be deducted from the tax returns (income) in the redeeming year.
Exercising Stock Warrants on Eqvista
You can exercise your stock warrants on the Eqvista app, and record all the information of the exercise all online. This will help you easily store the information in one place and share the details with other users without sending a single email.
Once you have the details of the stock warrant exercise, follow these steps on the app.
From the Warrant pool page, choose which warrant you would like to exercise.
Once you have clicked into the Stock Warrant Grant, go to the action bar and click on “exercise to equity”, which will bring you to this page.
You can choose to have a full or partial exercise, along with the exercise date and new share grant name.
After exercising the warrant, you can see the new shares on the app in the share class.
It’s also important to record the details of the stock warrant exercise in the Secondary Transaction list for use later. Here you can see the information of this under the “exercise” tab in the Secondary Transaction list.
And just like that you can easily exercise your company stock warrants and store the details of this all through the app.
To summarize, there is no denying that stock warrants are incredibly invaluable tools that companies worldwide use to draw in investors. Furthermore, when you exercise stock warrants, it is best to tread carefully. That is because any oversight on your part can have drastic consequences. One of the best strategies (as mentioned above) is to contact a broker. They will answer all your questions and guide you regarding what steps you need to take to exercise your stock warrants. Otherwise, stay in touch with your company for your warrant exercise, or if you are a company issuing warrants to your shareholders, use advanced equity management software.
Eqvista is an advanced Cap Table software that can manage and record all your stock warrant exercises. Our online software also helps companies issue and track their company shares and manage different types of company shareholders.