WARRANTS AND WARRANT AGENTS

What are Warrants?

Warrants are a type of security issued by companies for the purpose of raising capital perhaps to facilitate business expansion or fund projects. The investors who subscribe to a company’s warrants are called warrant holders. Warrants basically give such investors the right (not an obligation) to purchase a specified security of the company, usually stocks, at a fixed or determinable price within a period of time, after which the warrant expires. One of the attributes of warrants is that warrant holders stand a chance of benefitting from the projected growth of the issuing company such that if the underlying security increases in value during the term of the warrants, exercising their warrants would enable them purchase the underlying security at a discounted price. This arrangement suggests the possibility of a win-win situation for both the company and the warrant holders if everything goes well. Emphasis on the word “possibility” as the value of the underlying security could also drop.

Warrants could be issued by both private and public companies in private placements or public offerings. In most cases, warrants are issued alongside other types of securities, mostly stocks. In recent times, some companies have also issued other forms of convertible securities such as debentures and subscription receipts with warrants as the underlying security. It is often said that warrants are used to sweeten financing deals, and especially in uncertain times, issuance of warrants alongside other securities in a deal could serve as an incentive to prospective investors. It is also not uncommon to see warrants being issued as consideration in mergers and acquisition deals. However, the scope of this article is limited to the vanilla warrant deal which basically involves the issuance of warrants (specifically call warrants) to investors with little or no complexities.

In order to validly issue warrants under applicable Canadian laws, there are certain regulatory requirements the company must meet. Particularly, the distribution has to comply with applicable securities laws in each of the jurisdictions where such warrants are being issued. Another factor that issuing companies need to consider is the applicable stock exchange requirements if the warrants and/or the underlying securities will be listed on a stock exchange.

The Role of Warrant Agents

Depending on the complexity of a financing deal, the issuing company may choose to engage the services of a warrant agent. The warrant agent is basically a service provider engaged to coordinate the issuance, registration, transfer, exchange and exercise of the warrants. Most administrative matters that come up during the term of the warrants are overseen by the warrant agent on behalf of the company. It is important to mention that this is often an agency role with no fiduciary responsibilities whatsoever.

The scope of a warrant agent’s involvement and the terms of the warrants are governed by a warrant indenture which is executed by both the warrant agent and the company. Most warrant agents in Canada are licensed trust companies or financial institutions that have built expertise and structures to help coordinate all the administrative matters relating to a warrant deal. As warrants are held for a considerable period of time (usually between 1 to 3 years), engaging the services of a warrant agent could be tremendously beneficial to the issuing company as well as the warrant holders.

When a company’s warrants are widely held, or a significant number of the warrants issued are held electronically within the Canadian Depository for Securities (CDS), having a warrant agent as the middle man to coordinate the administrative issues that come up during the term of the warrants is something the issuing company should consider exploring. For example, warrant exercises require warrant holders to submit certain documentation like the warrant certificates, properly completed exercise forms alongside cheques in the amount of the aggregate exercise price for the warrants to be exercised. The duty of a warrant agent in this situation would be to accept and review the documentation, coordinate the issuance of the underlying securities with the company and the transfer agent of the underlying security, remit the exercise funds to the company and basically resolve issues that come up in the entire process.

Also, the warrant agent maintains the warrant holder register and usually helps with delivering notices to warrant holders as instructed by the company or when an event is triggered under the warrant indenture. As there could be a lot of back end work associated with warrant exercises, issuance of notices, transfers, replacement of lost certificates etc., warrant agents are usually well suited to manage the workflow, taking the burden off the company and enhancing great investor experience.

Acceleration Clauses in Warrant Indentures

As indicated earlier, warrants are usually valid for a specified period of time. This implies that a warrant holder can only validly exercise the warrants held prior to or on the expiry date indicated on the warrant certificate and indenture. Of course, the decision to exercise a warrant is largely dependent on market movements and particularly the price of the security underlying the warrant.

While one of the goals of most companies is to ensure that investors derive value from their investments, some companies also tend to incorporate an acceleration clause in the warrant indenture. Basically, an acceleration clause would provide for the ability of the company to accelerate the expiry date of the warrants in the event that the volume weighted average closing price of the issued and outstanding common shares of the company is greater than a specified amount per common share for a specified number of consecutive trading days. When the acceleration clause is triggered, what typically happens is that the company will give notice to the warrant holders and indicate the need for the warrants held to be exercised within a given period otherwise the warrants become expired as of the accelerated expiry date.

Choosing to accelerate the expiry date is usually at the option of the company and most companies would choose to exercise such right. One advantage of doing so is that, it creates a shorter window within which the company can raise additional capital from its existing warrant holders who exercise their warrants prior to the accelerated expiry date. Also, this creates an opportunity for the warrant holders to maximize the benefits of the warrants held by purchasing the underlying security at a discounted price. As such, it is important for warrant holders to keep tabs of the company’s performance and have updated records with the company or warrant agent so they don’t miss the acceleration event or the notice.

Conclusion

As companies continue to look for creative ways to stay afloat, fund operations, execute projects, or even expand in these uncertain times, the need to strategically structure financing deals cannot be overemphasized. Warrants have over time been identified as deal sweeteners, and perhaps this is a good time for more companies to evaluate the pros and cons of issuing warrants. The determination of the appropriateness or otherwise of issuing warrants is often based on a number of factors including, the market projections, the peculiar needs of the company, and whether or not a warrant issuance will in any way motivate investor participation. Also, the role and value of warrant agents should not be overlooked.

Dunni Shodipo is a corporate finance and securities lawyer currently practicing within the Canadian capital markets.

Please note that the views expressed in this article are those of the author only, and do not reflect the position of any institution with which the author is associated. This document is intended for informational purposes only and is not legal or investment advice or a substitute for consultation with a licensed legal, investment or other professional in a particular case or circumstance.