Companies with outstanding warrants have an alternative method to raise capital through inducing existing warrant holders to exercise outstanding warrants. In a typical warrant inducement offering, the issuer grants new replacement warrants to warrant holders who exercise outstanding warrants for cash. A warrant inducement offering can be an attractive alternative to companies during tough market conditions as these transactions can move on an extremely fast timeline. One contributing factor to the speed of these transactions is the past relationship between the issuer and warrant holders which allows for form transaction documents to be prepared in advance of ideal market conditions.
In a typical warrant inducement offering the replacement warrants are issued in reliance on the exemption provided by Section 4(a)(2) of the Securities Act of 1933, as amended, as transactions not involving a public offering and/or Rule 506 promulgated under the Securities Act as sales to accredited investors. It is not uncommon for warrant holders to require the issuer to register the shares underlying the replacement warrants for resale within a set number of days after the offering.
Pros:
- Speed and flexibility – the underlying transactions documents can be prepared early, which allows for speed and flexibility in completing the offering.
- S-3 “Baby Shelf” rules are inapplicable – issuers eligible for use of Form S-3 can register the shares underlying the newly issued warrants on a resale Form S-3 and will not be subject to Baby Shelf rules, which limits other offerings for small-cap or micro-cap issuers with a non-affiliate market cap of less than $75 million.
- Synthetic shelf – by issuing new warrants companies can create “synthetic shelfs”, or grouping of warrants that could be used to raise capital in future warrant inducement offering. This can be a double-edged sword for the reasons discussed below.
- Timing of disclosure – disclosure is not required until the warrant inducement is complete, which can limit downward pressure on the issuer’s stock price.
Cons:
- Exercise price of existing warrants may need to be reduced or offering delayed – existing warrant holders are unlikely to agree to exercise their outstanding warrants at the existing strike price if the current market price of a company’s common stock is lower. Companies may need to approve a reduction in the exercise price of existing warrants leading to lower proceeds for the company or wait for opportune market conditions before approaching existing warrant holders.
- Number of warrants issued may exceed those exercised – to induce warrant holders to exercise outstanding warrants companies may need to issue more than a single replacement warrant and could need to issue two or three new warrants against every one warrant exercised.
- Additional dilution and warrant overhang – Existing stockholders will face greater potential dilution based on the number of new warrants issued. These offerings can lead to an excessive warrant overhang.
- Types of outstanding warrants – if the vast majority or all of a company’s outstanding warrants are pre-funded warrants, then a warrant inducement offering is unlikely to make economic sense because the company will have already received most of the exercise price.
- Risk of tender offer – if a company has a large number of warrant holders, it could risk triggering the tender offer rules if too many holders are solicited. Needing to comply with the tender offer rules would negate many of the pros listed above.
Before structuring a warrant inducement offering, a company should consider:
- NYSE or Nasdaq requirements
- As a non-public offering, warrant inducement offerings will be subject to stockholder approval for an issuance of 20% or more of the issuer’s outstanding common stock. Companies will need to make sure the offering is below the 20% threshold, meets the rule’s exceptions, or that stockholder approval is obtained.
- Companies will also need to make sure no potential investor would trigger a change of control under the NYSE or Nasdaq rules. If a technical change of control is possible, beneficial ownership blockers in the new warrants may be a potential solution to avoid a change of control.
- Beneficial ownership limitations
- Existing warrants being exercised may have beneficial ownership limitations which will require the company to hold shares in “abeyance” until such time that the exercising warrant holder is under the applicable beneficial ownership limitation and able to receive the shares.
- Existing warrants
- The number and types of outstanding warrants, the number of warrant holders, and whether existing warrants permit a reduction in exercise price.
- Effect of additional warrants
- The possible effects additional warrants will have, such as accounting for abeyance shares.
If you have any questions about warrant inducement offerings please contact a member of Harter Secrest & Emery’s Securities and Capital Markets group.