Early Stage Funding · Startup Funding

Are warrants a dangerous investment structure for early stage startups?

Syam Vemula Senior BI Consultant at InfoMagnus

November 7th, 2016

Let's say we are talking about a seed stage startup that is going from idea to execution.

Here is the example- A seed stage startup receiving a $10K investment without equity or debt in exchange, and in return the funding source receiving a stock warrant to purchase about 16 to 18% of the company over a period of 5 years with predetermined valuations for each year. It is on a fully diluted basis, includes standard terms regarding net exercise, not-circumvention, etc.

To put this into perspective, if the funding source was to present an exercise option in year four, and the present valuation was $5M, the funding source would pay $1.5M to exercise the option.

Is the above acceptable? How do you see warrants as a method to fund early stage startups? Look forward to a healthy discussion.
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Thomas Kaled Business Development Consultant @ thomas.kaled@gmail.com

November 8th, 2016

Typically warrants are a useful and often cost-effective capital acquisition methodology for Companies performing within or beyond plan. However given the example you cited they appear to be a risk aversion mechanism or a 'long shot bet with low cost entry'.

Couple the 10K warrant purchase with significant capital upfront and decouple % of ownership that the warrants will represent when exercised. At $5 Million valuation a Company has nondilutive methods for access to capital (albeit not $1.5 Million) or potentially greater return for it's equity (beyond $1.5 million) at lower dilution to current shareholders than you have proposed.

The exception to my statements are if the Warrant plan you outline is a 'key employee' incentive plan however the percentage statement holds in any situation.