Founders of startups often have concerns regarding the characteristics of our financing solutions such as early payment clauses and debt covenants.
They often wonder whether we need a personal guarantee. Our Investment Team at Lighter Capital hears it all.
Stock warrants are often used by venture lenders as part of their “risk capital” structure.
So, it is because of the great upside potential and accompanying high risk.
The second and third issues have already been addressed, but a stock warrant may still be a mystery to you.
What is the procedure for issuing debt warrants?
And do we need them at Lighter Capital to get financing?
These are great questions, and we will answer them all so you can make an informed loan choice for your company.
Contents
What Is a Stock Warrant?
When a lender issues a warrant, it gives the borrower the right to purchase shares in the business.
However, depending on the lending institution, a debt warrant may also be a loan condition needed as part of a venture financing agreement.
Warrants are usually given as an incentive to investors in return for their investment.
However, If they are utilized, they must be issued by the borrower, regardless of how they got there.
There are debt warrants in the form of protection. In addition, they are typically between 5 and 10 percent of the lender’s investment in your company.
You may be asked to offer a ten percent warrant coverage on a $500,000 loan.
The lender will get a warrant entitling them to buy $50,000 of your company’s shares in exchange for the warrant you supply.
The upfront equity requirement of VC and its consequences make a warrant seem to be a low-risk option for obtaining working cash.
However, there are still certain things to consider before completing the transaction with a warrant.
A stock warrant is a contract that gives a lender the right to purchase shares at a certain price in the future.
For instance, the opportunity to purchase $X worth of your company’s shares.
Many venture loan lenders demand warrants and anticipate that warrants will account for half of their overall profits.
For the lender, the stock warrant may be very valuable if your company succeeds.
What’s the Risk Concern with Stock Warrants?
To convince and reward a lender to invest in your SaaS company, you may utilize warrants.
Keep in mind, however, that they are doing the same thing that a non-VC investor would do.
Moreover, it is entirely up to you whether or not you want to take a chance. We never accept warrants for our loans at River SaaS Capital.
This is also true of many other venture capitalists.
For this reason, you must look into all of the choices available to your company and its workers (some of whom may be shareholders).
Stock warrants have three major flaws:
- Do the arithmetic on how much any warrant will cost you if your predictions come true before purchasing one.
- When times are good, stock warrants match the interests of the lender and the company, but when times are tough, they don’t.
- A “put option” is often required by lenders.
After a set number of years, the lender has the option to repurchase the warrant from the business.
Assume this payment, which may be substantial and stifle your startup’s capacity to expand, will be expected of you.
Also Read: 7 Ways to Double Your Money (Fast)
Why Do Venture Lenders Require Warrants?
When a borrower business does well, venture lenders utilize stock warrants to reserve the right to a part of the earnings.
Many venture loan lenders demand warrants and anticipate that warrants will account for half of their overall profits.
If a lender invests in the next unicorn and it goes public for $5 billion, the lender wants to make a profit on the investment.
The venture lender’s stock warrant coverage in the few big exiting firms balances the more frequent and greater defaults experienced by some of their smaller borrowers.
Stock warrants only protect venture lenders from the upside; they do not protect the downside.
Having a debt warrant does not assist a venture lender to avoid or recovering losses if a business fails.
In contrast, the venture lender stands to gain from the company’s success if it goes public in a big way.
Stock warrants are often used by venture lenders as part of their “risk capital” structure because of the great upside potential and accompanying high risk.
How Do Debt Warrant Work?
Venture lenders wait for the price of each share to increase beyond the “strike price” before using stock warrants when a business is having a liquidity event, such as an IPO.
A venture lender’s warrant, for example, may have a strike price of $25 per share, which means it will only buy the company’s shares if it climbs beyond that price.
Most of the time, the stock will instantly begin to trade higher than the warrant’s strike price as it is issued.
In this case, the warrant is useless since the stock price will never increase beyond the strike price.
Example Of How Stock Warrants Work:
As an example, consider the following situation:
An early venture lender had warrants for 400,000 shares of Roku’s preferred stock, with an exercise price of $9.17340 when the company went public in 2017.
Roku’s share price opened at $15.78 on its first day of trade, already above the venture lender’s strike price.
To execute the stock warrant, the lender had to pay $9.17340 for each of the 400,000 Roku shares it owned.
This amounted to a total of $3,669,360. The warrant was worth $2.6M net to the lender (or $6.6066 per share) in this situation.
Instead of the warrant, this would have been a win-win situation for the lenders and the other parties involved.
Usually five years after the loan ends, if a business does not experience a liquidity event, a stock warrant will expire.
Because the lender can no longer act on them, the issuing business no longer sees them as a liability.
Lighter Capital’s Approach to Lending:
For this reason, we take a non-dilutive approach to financing. When it comes to lending, we like to think we do it better than anybody else.
We build partnerships based on the belief that businesses may be carefully assessed and appropriately financed with minimum risk, enabling founders to retain full control of the companies they have created and to avoid diluting their ownership in any manner.
As part of this strategy, none of our borrowers are required to provide stock warrants.
Our method does not work with stock warrants because they are complicated, cumbersome, and involve the transfer of ownership.
Why You Don’t Require Stock Warrants?
As a high-risk growth capital lender, Lighter Capital focuses on companies with tremendous growth potential.
In contrast, to venture capital lenders, we do not take a stake in the company when we make a loan.
This is an important distinction. We are aiming to leave the entrepreneur with all the benefits.
When it comes to early-stage venture capital funding, dilution is inevitable.
But we do not use stock warrants because founders should never dilute. Instead, we believe founders should simply be aware of when they dilute.
If your startup is successful, the venture lenders who took stock warrants will walk away with a huge profit.
After looking into non-dilutive funding options, it is best to dilute as little as possible.
Moreover, it will help you to fuel growth in the early stages.
It gives founders more negotiating power with venture capital investors if they hold off on accepting stock warrants until after their valuation has increased.
The smaller a percentage of a company warrants represent on a pro-rata basis, the higher the company’s valuation will be.
It is Lighter Capital’s goal to help startups in their early stages grow without transferring ownership of the company to the investors.
Startups should have more choices, whether that means utilizing alternative financing to develop organically or using private equity at a premium valuation to speed up growth.
That is our objective. We would rather not utilize warrants in this capacity since it dilutes our financing.
In Addition, Here are Some Useful Links:
Lighter Capital is redefining startup finance by eliminating the need for stock warrants as a requirement for funding.
Learn why entrepreneurs are turning to debt capital alternatives like revenue-based financing to drive their startups’ development by downloading our free Alternative Finance Industry Report.
Also Read: Swell Investing Review: My Experience Using Swell
The Verdict!
As an accelerator might Lighter just recruited a new head of the community to help connect and serve startups.
By looking across their portfolio to comparable businesses, Lighter may provide entrepreneurs anecdotal input regarding turnover or budget based on the data it has.
For a business, a Lighter Capital solution is the best option.
