Share Warrants: Meaning, Types, Benefits & Examples

The Indian financial market includes various securities and financial instruments. To make informed financial decisions, you must be aware of what these instruments are and how they work. While most people are familiar with equity shares , among the most common types of securities, few investors know what a share warrant is.If you, too, are unaware of the meaning of a share warrant, this article sheds light on what a share warrant is, how it works, the different types of warrants in India, how they are taxed and more. Also read: Stock Market Index: Meaning, Importance and More

A share warrant is a contractual document issued by a company. It gives the warrant holder the right or the option to purchase or sell the company’s shares at a specific predetermined price. The trade can occur on a specified date or within a predetermined period. Since share warrants give the holder the right to buy or sell the issuing company’s shares, they are considered securities per the Securities Contracts (Regulation) Act, 1956.

To better understand what a share warrant means and how it works, let’s discuss a couple of examples. Take an American-style share warrant issued by a company for 500 shares at a price of ₹300 per share. Say this warrant can be exercised within five years of issue. So, if you hold this share warrant and wish to exercise it when the company’s share price in the market is ₹450, you can purchase 500 shares at just ₹300 each instead. However, if you do not exercise this warrant within five years, it expires worthless.Similarly, consider a European-style share warrant issued by a company for 1,000 shares at a price of ₹800 per share. Say this warrant can be exercised on a specific date. So, if you hold this share warrant, you can exercise it on the specified date to buy 1,000 shares in the company at ₹800 each, even if the company’s share price in the market is, say, ₹1,100.

The money received against share warrants can be useful to the issuing entity in several ways. So, companies may issue share warrants for different reasons, including the following:

• Raising Capital Share warrants are an effective tool for companies to raise capital without immediately diluting their share capital. In addition to the money received against share warrants, these securities also provide a future source of funds as they can be converted into equity shares later.
• Attracting Investors Warrants can be an attractive option for investors because they offer the potential for future profits. Investors get to purchase shares at a predetermined price, and this can be particularly appealing in bullish markets or during periods of market volatility or economic uncertainty. Also read : What is a Volatility Index?
• Employee Incentives Companies often use share warrants as a part of employee remuneration packages. This aligns the interests of the employees with the company’s performance because the value of warrants is tied to the company's stock performance.
• Financing Flexibility Share warrants also offer financial flexibility to companies. They can be structured in various ways to suit the company’s strategy of raising capital. This offers organisations the option to access funds in a deferred manner without immediate equity dilution.
• Strategic Partnerships Issuing share warrants can also be a strategic move to build partnerships or alliances. Companies might issue warrants to other firms as part of a strategic investment or collaboration, thus offering them potential equity participation in the future.
• Market Positioning By issuing share warrants, companies can position themselves favourably in the market. It signals confidence in the future growth prospects of the company, may potentially attract more investors and boost the company’s profile.
• Cost-Effective Financing Compared to direct equity issuance, share warrants can be a cost-effective financing option. They usually involve lower immediate cash outflows and can be a cheaper alternative to traditional equity or debt financing.

To issue share warrants, companies need to fulfill various conditions outlined by regulatory bodies like SEBI. There are also conditions for the issue of share warrants in company law. Let’s explore these details.A company may issue share warrants if:

• It is a public company
• Its articles of association (AoA) permit such an issue
• The shares for which such warrants are issued are fully paid-up
• The central government approves of such an issueIn addition to the above criteria, the Securities and Exchange Board of India has outlined the following conditions in the SEBI (ICDR) Regulations, 2009.
• The tenure of share warrants must not exceed 18 months from the allotment date
• No more than one warrant should be attached to one security
• The company must decide the price (or the conversion formula) of the share warrants upfront
• At least 25% of the consideration should be received at the time of issue

Also read : Understanding Memorandum of Association: Meaning, Content, and Forms

Depending on the type of rights offered, share warrants can be one of two types. Let’s examine these types of warrants in India more closely.

• Call Warrants Call warrants give the holder the right, but not the obligation, to buy a specific number of shares in the company at a predetermined price (known as the exercise price) within a set timeframe. These warrants benefit investors who anticipate that the company's stock price will rise in the future. By exercising the call warrant, they can purchase the stock at the lower exercise price, leading to a potential profit if the market price is higher.
• Put Warrants Conversely, put warrants allow the holder to sell a specific number of shares at a predetermined price within a certain period. These are advantageous in scenarios where the investor expects the stock price to fall. By exercising the put warrant, they can sell the shares at a higher exercise price than the current market price, potentially mitigating losses in a declining market. That said, put warrants are not frequently issued since they involve anticipating bearish price movements.

The taxation of share warrants in India depends on the provisions of the Income Tax Act, 1956. Here’s how these securities are taxed at different points:

• On Issue or Subscription: No tax implications arise when share warrants are issued by a company or when an individual subscribes to these securities.
• If the Warrant is Not Converted to Shares: If the warrant holder does not convert the securities into shares, the premium (the money received against share warrants) is forfeited. The subscriber or warrant holder can claim it as a capital loss.
• If the Warrant is Converted to Shares: If the warrant holder converts the securities into shares, it may result in taxable income. This income is the difference between the market price of the shares and the strike price of the warrant. This is a part of the subscriber’s ordinary income and isn’t considered capital gains.
• When the Shares are Eventually Sold: When the shares are sold at a profit at a later date, they will result in capital gains, which are taxed as per the regular provisions of the Income Tax Act.

Also read: What is Capital Gains Tax? - Types, Tax Rates & Calculation

The benefits of share warrants for the subscriber include the following:

• Leverage Share warrants provide the leverage effect and allow investors to benefit from a share price movement without owning the shares outright. This requires a lower initial investment compared to buying the actual stock.
• Potential for High Returns Due to their leverage, share warrants can offer higher returns compared to directly investing in the stock, especially if the stock performs well before or on the expiration date.
• Flexibility Investors can choose from different types of warrants (like call or put warrants) and strategies based on their market view and risk appetite.
• Lower Risk than Direct Stock Purchase If the stock does not perform as expected, the maximum loss for the investor is limited to the amount paid for the warrant, unlike potentially higher losses in direct stock investments.
• Diversification Warrants add diversity to an investment portfolio and offer a different risk-return profile compared to traditional stock investments.

Despite their advantages, share warrants also have some downsides, as outlined here:

• Time Decay Warrants have an expiration date. If the stock does not move as expected before expiry, the warrant becomes worthless.
• Limited Rights for Subscribers Warrant holders do not have the same rights as shareholders, such as voting rights or dividends .
• Liquidity Issues Depending on the warrant and the market, some warrants might suffer from low liquidity, making it difficult to buy or sell them quickly at market prices.
• Risk of Loss While the risk is limited to the warrant's price, this investment can still result in a 100% loss if the warrant expires out of the money.

Although both share warrants and options give the holder a right without a corresponding obligation, the two are vastly different in many ways. The table below encapsulates these differences.

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This sums up the fundamentals of share warrants and how they work. When exercised smartly, they can add to your wealth-creation journey. However, it is important to keep the limitations in mind to avoid the downsides of share warrants, like time decay and liquidity issues. The trick is to strike the right balance and leverage the advantages of these securities. Also read : GTD in Stock Market