Underwriter’s warrants constitute a mode of compensation that may be granted to an underwriter by a company that issues stock. Essentially, the corporation will issue common stock warrants directly to the underwriter as part or all of the compensation involved with arranging the sale of the stock to the general public. Underwriter’s warrants allow underwriters the right of access to a fixed amount of shares, often at a price that is below the initial offering price made to the public.
Because underwriter’s warrants are compensation through the issue of common stock warrants to the underwriters, it is important to understand what constitutes a common stock warrant. Essentially, a warrant of this type provides the holder of the warrant the right to purchase shares of common stock that are issued by a given corporation. While terms and conditions may vary slightly based on laws governing financial transactions in the jurisdiction of origin, the common stock warrant normally provides some degree of protection to the warrant holder in regard to the right to purchase shares and the unit price per share that will apply.
The issue of underwriter’s warrants as part of the compensation package to the underwriter is a common practice, and one that can ultimately prove lucrative for the underwriter. Assuming that the stock performs well when released to the general public, the underwriter can stand to make a considerable profit by exercising the terms associated with the warrant. It is not unusual for underwriters to agree to compensation packages that include fixed rates for services rendered and the issue of underwriter’s warrants as an incentive to aggressively market the stock options.
In very limited instances, an underwriter may choose to accept underwriter’s warrants as the bulk of the compensation for selling shares to investors. This most often occurs when the underwriter has an extremely high confidence level in the projected success of the stock option, and believes the benefits derived from the acceptance of the warrants will exceed accepting a more traditional compensation package. However, this should be approached with caution, as the underwriter assumes a much higher degree of risk in terms of lost compensation if the stock fails to perform within expectations.