Startup warrants are different from stock options or equity in a new venture that founders are starting. Many incubators work with warrants instead of taking equity for the program as warrants are more attractive to founders. What should founders know about warrants in a startup and has anyone had any experiences with them that would be valuable for others to know?
Similar to options, warrants provide their holders the right to purchase shares at a pre-arranged price and, upon exercise, give the holder stock in the company. This is an agreement, like a contract, to make that transaction in the future, effectively paying the service provider upon your success, without you allocating equity and a shareholder position at this time. Despite being less well-known than conventional equity shares, warrants can be a useful tool for coordinating incentives between a Startup and its strategic investors. Entrepreneurs creating businesses with an enterprise emphasis should be aware of how to use warrants to align incentives and foster stronger collaborations.
Performance-based Warrants are a potent tool for coordinating incentives between a startup and a key partner from a strategic standpoint. They enable a startup to recognize and reward partners who have contributed significantly and achieved the predetermined objectives or milestones. Warrants can be made to vest gradually, but experience shows, they work best when they are connected to performance-based triggers or other precise deadlines. The goal of aligning incentives between a startup and their investor or partner is undoubtedly a good one, and warrants force organizations to monitor and assess the performance of their collaborative efforts. Most importantly, granting Warrants entails less risk for startups because there is no share dilution, and the Warrants cannot be exercised if your partner fails to perform.
When it comes to Warrants for Services: It’s typical for startups to give warrants to partners or other stakeholders that help them out by providing services. For instance, in what is basically an exchange of services for potential equity, a business may grant Warrants to an incubator or accelerator. In exchange for Warrants, incubators or accelerators may offer buildings, infrastructure, administrative help, cloud credits, talent, or other resources that a startup lacks. Similar to this, in return for signing an OEM (Original Equipment Manufacturer) agreement or licensing intellectual property that may turn out to be valuable in the long run, Warrants could be given to a strategically significant partner who might not have a venture capital arm or the ability to make a direct equity investment.
Performance-based Warrants can be a useful instrument to align the interests of a startup with other stakeholders or business partners in a wide range of settings. They not only make it possible for both parties to benefit from successful cooperative activities, but they also aid in formalizing these agreements, motivating both parties to track and evaluate their progress.
