I frequently hear clients and some of their advisers talk about “stock options” and “stock warrants” and there is often considerable confusion between the two. In this post, I’ll briefly describe the major distinctions between these instruments and how each can be used in a privately held company.
Stock options are issued to key employees, directors and other service providers in exchange for services rendered to the company/employer. Generally, there is a stock option plan under which a set number of options (and often restricted stock) can be issued to one or more key service providers to align their interests with the interests of the employer. The option is a compensatory vehicle that is intended to increase the key service provider’s overall compensation if the company’s stock price increases.
On the other hand, warrants are not compensatory vehicles. Instead, they are issued in connection with the company’s raising of capital, either debt or equity securities, and are used to “sweeten” the deal for the investor. So for example, suppose a technology company is raising capital through a Series A Round and wants to incentivize the first investor who joins the deal by giving it “something extra.” In this case, a stock warrant could be issued to the first investor to purchase X number of shares of the company’s common stock at $Y per share. This stock right is issued in connection with a capital transaction and is designed to increase the overall return on investment to the first investor. This vehicle is properly called a warrant.
Another common example would be a stock warrant issued in connection with a debt transaction. To induce the investor to loan funds to the Company, the company might give the investor a warrant to purchase some number of shares of stock which, from the investor’s standpoint, will hopefully generate a higher total rate of return on the overall transaction.
The tax rules governing options and warrants are completely>>> READ MORE at: