You’ve probably heard about stock options and stock warrants, but do you know the difference between the two?
If this question leaves you scratching your head, you’re not alone. Mixing these up is more common than you’d think.
Stock warrants and stock options are terms that are regularly mentioned during discussions about equity compensation – but the reality is, not everyone knows the difference between the two, even investors who deal with stocks on a daily basis fail to differentiate.
We all are familiar with the benefits of options. Issuing stock options and warrants to employees helps companies attract, and engage the best employees. It gives employees a vested interest in staying with a company and incentivizes them to work hard and contribute to its success. If an employee has an equity share in a company, he or she gains financially when the company succeeds.
Employee ownership is one of the best ways to retain top talent. It’s a win-win situation. However, not many of us know the actual difference between them and which one should be incorporated into equity compensation plans.
Here, we take a look at the nitty-gritty of warrants vs options.
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 particular price and by a specific date. Depending on the type of option, they may buy or sell their options if/when the price of the stock goes up or down.
Employees are 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 company issues stock directly to the employee.
Employees receive a warrant certificate, which includes the terms of the warrant, expiration details and when it can be exercised.
The warrant certificate is not ownership; it’s the right to purchase company stock at a specified price on a particular date in the future.
What are the pros of warrants?
Warrants are a great way to benefit from a company that’s likely to do well in future without having to put your investment at risk. Not every company is a success – in fact, many start-ups 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’s success 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 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 i.e. most warrants come with an expiration date of either five or 10 years.
So what’s the difference between warrants and options?
The main difference between a stock warrant and a stock option is how they originate – warrants are issued by the company itself whereas stock options are listed on an exchange.
A company can raise capital through issuing warrants, whereas it doesn’t make money from the transactions in which stocks are exchanged. Warrants generally have a longer life span and no vesting restrictions which is not the case with the options.
Want to learn more?
Whether you’re completely new to equity compensation or looking to improve your knowledge, our Equity Explained series can help you learn all about the world of employee ownership.
How can we help?
So now you know about the difference between stock options and stock warrants, but if you’re struggling to decide which is best for your company, get in touch with us today. Our team of equity experts can help you design an equity compensation plan that is tailored to your specific needs and will allow your employees to reap the benefits of employee ownership.
With Global Shares, equity compensation is easy – from plan design, onboarding and grant issuance to financial reporting, trading and compliance – we have it covered.