A put warrant is a company-issued contract to sell back stocks at a specified price and on or before a specific date.
Put warrants can be issued independently but are often issued as a sweetener with a debt or equity instrument.
Let us discuss what is a put warrant and how does it work.
What is a Put Warrant?
A put warrant basically gives the holder the right but not an obligation to sell an underlying asset at a given price and on or before a specified date.
Generally, the arrangement allows an investor to sell back issued shares at a specified price in the future. The arrangement works similarly to put options with a few key differences.
A warrant is basically a right, not an obligation to buy or sell shares at a future date. When it offers a right to buy shares, it is a call warrant. When it offers the right to sell shares, it is a put warrant.
A stock warrant is always issued by the company itself. It means when the investor exercises the warrants, the company would need to issue new shares. In case of put warrants, the company must buy the shares from investors when exercised.
How Does a Put Warrant Work?
As mentioned, put warrants are issued directly by a company. The issuer must specify the strike price, maturity date, and other terms with the offer.
Investors hold the right but not an obligation to sell the shares of the company at the strike price. American put warrants can be exercised any time before the expiry date. European put warrants can only be exercised on the expiry date.
Put warrants are issued when issuers require capital for long-term projects. These warrants usually come with a maturity period of ten to fifteen years.
Investors can use put warrants for hedging risks against the declining stock price as well. When the stock price falls below the exercise price, investors will be in the money. Contrarily, when the stock price is above the exercise price, they will be out of the money.
Why Companies Use Put Warrants?
Warrants are typically issued as an inducement or a sweetener along with debt. Often, these warrants are detachable from the security. Hence, investors are lured in for better gains with warrants attached to a debt or equity instrument.
Issuers of put warrants can raise capital for long-term projects. Unlike options, warrants are issued when issuers require capital for the long run.
Unlike options, warrants are issued and traded by companies. It means they can offer better terms and control the trade with investors. In return, they can get better financing terms such as lower interest rates when used as attached warrants.
Warrants require issuing new shares. It means warrants can have a dilution impact on the issuing company as well. However, put warrants can be a good option when an issuer is in financial distress and looking for long-term and cheaper financing options.
Accounting for Put Warrants
Generally, stock warrants are accounted for under ASC 470 as freestanding instruments issued by a company. However, certain types of warrants such as put warrants fall under the scope of ASC 480.
The first step for the reporting entity is to determine whether the put warrants satisfy all the conditions under ASC 480.
ASC 480-10-55-30 guides that put warrants create a conditional obligation for an entity to repurchase shares at a specified date and price for cash or in exchange for any other asset, thus, it falls under the scope of ASC 480 as a liability.
Some put warrants that are settled through an asset such as shares may also fall within the scope of ASC 480.
An excerpt from ASC 480-10-55-30 reads:
“Consider, for example, a puttable warrant that allows the holder to purchase a fixed number of the issuer’s shares at a fixed price that also is puttable by the holder at a specified date for a fixed monetary amount that the holder could require the issuer to pay in cash. The warrant is not an outstanding share and therefore does not meet the exception for outstanding shares in paragraphs 480-10-25-8 through 25-12″.
Thus, we conclude that puttable warrants are a form of liability within the scope of ASC 480.
Suppose a company ABC issued 100 puttable warrants with the given details.
- Par value of stock = $1
- Puttable warrant price = $5
- Strike Price = $20
- Share price at issuance = $ 23
ABC company recognizes the issuance of puttable warrants as a liability under ASC 480 guidance. The journal entry to record the immediate transaction will be:
|Liabilities- Put Warrants||$500|
Suppose ABC stock price falls to $20. The investor does not find any profit and instead exercises 30 warrants at $5. Then,
|Liabilities- Put Warrants||$150|
Suppose ABC stock price increases to $30. The investor would want to purchase shares at $20 yielding a profit of $10 per share using put warrants. ABC company will have to issue new shares.
Suppose the investor uses 50 warrants to buy new shares from ABC company. The journal entry to record this transaction will be:
|Liabilities- Put Warrants||$ 250|
|Additional Paid-in Capital||$ 1,200|
Similarly, ABC company can account for the changes in the value of outstanding warrants until maturity.
Put Warrants Vs Call Warrants
Warrants are of two types: put warrants and call warrants.
A call warrant gives the holder the right but not an obligation to buy stocks at a specified price on or before the maturity date.
A put warrant gives the holder the right but not an obligation to sell stocks at a specified price on or before the maturity date.
Both types of warrants are tools to raise capital for the issuers. Both offer some benefits and risks to the investors as well as the issuers. The issuers would consider their stock price trends, future plans, and forecasts to decide which type of warrant to issue.
Mostly, warrants are issued with newly issued debt or equity instruments. The aim is to attract investors for long-term financing needs.
Put Warrants Vs Put Options
Options and warrants are both financial instruments that offer similar rights to investors. Both come with the put and call features. However, the put warrants and put options have a few differences as well.
- Put Warrants are issued by the issuing company directly while put options can be issued by options exchanges.
- Put warrants come with a longer maturity period than put options.
- Put options come in a standardized form. They can only be issued in standard quantity, price, and maturity date. Put warrants can be issued with non-standard terms such as varying quantity and maturity date for various contracts.
- The terms and conditions of put warrants are determined by the issuing company, often, with the understanding of the investor. Contrarily, the terms of an options contract are determined by the options exchange.
- Warrants are often issued attached with debt or security instruments. Whereas, options are frequently issued independently.
Advantages of Using Put Warrants
Using put warrants offers several advantages to investors and issuers as compared to using put options (or other securities).
Investors can limit losses with put warrants for investments in illiquid stocks. It is particularly important when investing in small and private companies that are not listed yet.
Issuing companies can attract large investors by offering put warrants. It is specifically important for private, young, and growing companies with limited access to the capital market. When the investor can sell the stock back to the issuer, they feel safer with the put warrants.
Put warrants are issued to raise financing for the long term. It increases investors’ confidence and hence increases the share price of the company.
Put warrants also come with lower prices as compared to put options. It means they offer lower risk to investors overall. Also, put warrants offer better liquidity and profit margins to investors. They can also be used for hedging against falling price risks.
Disadvantages of Using Put Warrants
Put warrants offer some disadvantages to investors and issuers as well.
Foremost, put warrants are risky investments for investors as the issuers are the same as the stock owners. If the stock prices fall too much, the issuer may not be able to honor the put warrant.
Put warrants are often issued without collateral. On the other hand, put options are usually backed by collateral and are usually issued by exchanges rather than stock owners.
From the issuer’s perspective, the losses can be large if the stock prices fall too much. Also, if there is any collateral, the issuer may risk it as well. Issuers may not want to honor a put warrant but when they do, it may create liquidity and cashflow challenges as well.