Stock warrants and stock options are terms that mentioned regularly when it comes to discussions about equity compensation – but the fact is, not everyone knows the difference between the two, even people like investors who are working with and hearing these terms regularly. We do know that issuing stock options and warrants to employees helps companies attract, engage and retain the best employees. This is because it gives them a vested interest in staying with a company and working hard to contribute to its success. If an employee has equity in a company, they gain financially when it does well. Employee ownership is one of the best ways in which to engage with staff so that they grow and benefit alongside the company. It’s a win-win situation. When it comes to stock warrants versus stock options though, what’s the difference between the two and which should you be incorporating into your equity compensation plans? Here, we take a look at the nitty gritty.
What is a stock option?
When a company gives an employee a stock option, it means they have the right to buy stock in the company at a specific or strike price and by a specific date. Depending on the type of option, they may buy or sell their options if the price of stock is going up or down. They’re not obligated to do so, however – it’s just an ‘option’. Stock options can be traded on exchanges, just like stocks and when a stock option is exercised, the stock moves from one investor to another.
What is a stock warrant?
Like stock options, a stock warrant gives an employee the right to buy or sell stock at a set price on a particular date. Stock warrants are issued by the company as opposed to originating on the stock exchange. When a warrant is exercised, the stock is given from the company directly to the employee. They’ll receive a warrant certificate, which includes the terms of the warrant including details of when it expires and when it can be exercised. The warrant certificate is not ownership – just the right to purchase company stock at a specified price at a date in the future.
What are the pros of warrants?
Warrants are a great way to benefit from a company that’s doing well in future without having to put your investment at risk. Not every company is a success – in fact many start up companies fail. Therefore, people who hold warrants in their company can benefit from the success of a company if it does well. On the other hand, if the company fails, there is no need to exercise the warrant. So having warrants allows someone to reap the benefits of a company doing well without having to put their hands in their pockets and risk their own cash at the beginning. In a typical warrant agreement, there are a few things that need to be established – the number of stocks an employee can purchase in future, and the strike price or exercise price, which is the minimum future price they’ll have to pay to buy the stock. Warrants will also have an expiry date – most warrants come with an expiration date of either five or 10 years.
So what’s the difference between stock options and stock warrants?
The main difference between a stock option and a stock warrant is how they originate – warrants are issued by the company itself whereas stock options are listed on exchange. A company can raise capital through issuing warrants, whereas it doesn’t make any money from transactions in which stocks are exchanged. Warrants generally have a longer life span than options and typically warrants don’t have any vesting restrictions.
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