Thinking about using debt to grow your business, but worried about debt warrants?
It’s natural to be concerned about making the right financial decision for your business. You don’t want the terms of your finance facility to restrict your company’s growth plans or for that capital to come with considerable cost. Therefore, if you’re unfamiliar with the term ‘debt warrants’, we are going to explain what they are, what they mean for you, and why they exist.
What are warrants in finance?
In the early years, fast-growing tech businesses typically burn cash and take time to turn a profit. For this reason, they’re often considered too risky to attract traditional finance. Debt funds leverage finance warrants as an incentive to take on the risk.
What is a debt warrant?
A warrant in debt is similar to a stock option. There are two common warrants you should know about:
- Call Warrants – This is the lender’s right to buy shares at an agreed price on or before a specified date. The price is what’s known as a ‘strike’ price and it is agreed during the deal negotiations.
- Put Warrants – This gives the lender the security to sell a given quantity of shares for an agreed price on or before a date that is agreed during negotiations.
To put it another way, let’s say your company takes out a £1m debt loan with a 5% warrant coverage. Here, you give your lender the option to buy £50,000 in shares at an agreed price on the contract date. The warrant represents the equity kicker.
What happens when a lender exercises its loan warrants?
First things first, understand that warrants are typically only exercised on a ‘liquidity event’, such as a trade sale or an IPO.
If we refer to the earlier example, let’s say your company’s share value has increased by 50% and you decide to maximise profit with an exit strategy. Perhaps you plan to IPO or to exit via acquisition, your lender can use its warrants finance to buy and sell £50,000 of shares. Now that they’re worth £75,000, they yield it an ‘equity kicker’.
The benefits of warrants:
- Venture debt warrants don’t impede your growth or restrict your deployment of capital.
- They are interchangeable with interest rates and covenants.
- Warrants in Venture Debt are easy and inexpensive to set up.
- They’re cheaper than raising equity.
How much does debt with warrants cost?
In a typical loan agreement, a debt fund asks for finance warrants, over equity, of between 5% and 15% of the value of the loan.
Now that you understand the advantages of warrants, there is one last thing to note. Different debt funds use different measures to calculate warrant financing. To find out how our global lenders calculate their debt warrants, drop us a line, and we’ll set up a time to chat.
For a win-win deal negotiation (one with a mutually acceptable outcome) it pays to talk to an expert debt advisor.