Understanding the differences between stock warrants and stock options is important for leaders of private companies.
Your company’s equity will be a major way to attract new investors and employees as you grow. Stock warrants and stock options are both equity instruments that are likely to end up on your company’s cap table. While they’re quite similar, founders should be aware of some key differences.
In this article, we’ll break down the differences between these two equity vehicles and provide some context into how each should be used.
What is a warrant?
A warrant is a contract between two parties that gives the holder the right to purchase a certain amount of stock at a predetermined price, over a specified period of time. It is typically issued to investors as part of an equity financing round or to banks in a venture debt or loan deal.
What is a stock option?
Most private company founders are familiar with the idea of a stock option, which in this context refers to an ESO, or employee stock option.
Stock options give the holder the right to purchase a specific number of shares at a predetermined price, called the strike price. They are often seen as a way to attract and retain top talent, as employees given stock options have a greater vested interest in the company's success.
So what’s the difference between a stock warrant and stock option?
You may have read both of these definitions and thought: those two sound pretty similar. And you’d be correct!
While stock options and warrants do overlap in some areas, there are some key differences between the two.
We’ll run through a high-level compare and contrast exercise. If you’d like to dive deeper into the intricacies of each, it’s likely best to consult an attorney or financial advisor.
Who they’re issued to
As we mentioned, different people will be incentivized by different equity instruments. Stock options are typically reserved for employees, consultants or advisors: people that work directly with your company that you want to entice to stick around for the long term. When your company does well, holders of stock options have the opportunity to cash in.
Warrants, on the other hand, are typically used in financing deals with investors and banks. A warrant can be mutually beneficial for a venture capital investor and a founder. The founder avoids dilution in the moment by putting off the exchange of shares until a later date, and an investor has a chance to cash in with potentially more favorable terms in the future (more on that in a second). The same could be said for a venture debt or loan deal with a bank or other institution.
Where the shares come from
Next comes the topic of dilution. Stock options generally are sourced from an option pool that’s already been set aside for employees. Issuing stock options can still cause dilution, but typically not as severely.
When a warrant is exercised, on the other hand, a company must issue new shares to cover the number of shares promised in the warrant. The risk for dilution for founders and early employees is greater.
Price and value
The exercise price of stock options is determined by the company’s fair market value, which is calculated in the 409A valuation process.
Warrants, however, aren’t as beholden to FMV. Companies can offer warrants below fair market value, meaning the investor that obtains the warrant has the potential for a significant payday if the company is able to increase its value over time. In short, warrants have more upside potential.
How they’re packaged
Employee stock options are typically issued as part of a compensation package, alongside salary and other benefits.
Warrants, meanwhile, are typically attached to newly issued bonds or shares of preferred stock. It’s not as common to issue only a warrant to an investor; it’s usually part of a larger deal or transaction.
How to manage your stock options and warrants
Once you understand the similarities and differences between warrants and stock options, it’s time to understand how to track and issue them as you grow your company. It’s vital to keep track of both of these equity instruments on your cap table to keep an accurate picture of the ownership of your company.
Fidelity specializes in giving private companies confidence in their equity management. Our automated equity financing solution helps founders stay on top of their shares and company ownership.
Fidelity’s all-in-one equity management platform takes care of automated time-based vesting, stock splits, warrants, and other investment types. Every time there is an equity event, your capitalization table automatically updates and dynamically links directly to all supporting documents so that you have a single source of truth.
Founders can grant any type of equity (stock options and warrants included) and our workflows manage the entire process from start to finish.
Whether you need help with stock splits, warrants, or automated time-based vesting, Fidelity can help you handle it all.
Learn how Fidelity’s all-in-one platform can help you issue share-based incentives more efficiently and contribute to your financial growth by scheduling a demo.
Fidelity does not provide legal or tax advice.