Business Law / Affärsjuridik
What happens to your warrants
(Sw: teckningsoptioner) when an exit event happens?
In the sale of a privately held company, in addition to shares there will often be other securities outstanding. Hence the question may arise as regards how such securities should be treated and in particular how they should be priced in the exit.
Most typically, such other securities will be treated the same as shares in relation to drag and tag provisions in the shareholders agreement – if the shares are sold, so are the warrants. What may differ is how they should be valued. There are good arguments for various approaches, and understanding the difference behind in particular the two most common models will be relevant when deciding what approach to take (as the bidder on the share of a company, as shareholder, or as option holder).
Intrinsic value
Firstly, you may apply the so called intrinsic value, which is when you calculate the value as the offered price per share minus the warrant’s strike price. For example;
PPS: 100
Strike: 75
Value of warrant at exit: (100 - 75) = 25
If however you are facing e.g. a distressed sale in whichthe PPS is lower than the strike price, the value will be 0 (but it can never be negative):
PPS: 100
Strike 125
Value of warrant at exit: (100 - 125 <0); = 0.
Traditional option value
Secondly, you may apply fair market value calculated through a traditional option valuation, most typically Black-Scholes, to compensate the warrant holder for the remaining time value of the warrants. For example:
PPS: 100
Black-Scholes valuation: 80
Value of warrant at exit: 80
So which one should you choose?
To begin with, as regards how the two models relate to each other the basic difference is that applying the intrinsic value will mean that the expected value/time value inherent to a warrant will be lost. On the other hand, a risk for future illiquidity - especially in a private transaction - may indicate that the expected value should be significantly lower than what only a Black-Scholes calculation indicates (due to the impact of illiquidity on the price).
What alternative that is the most fair and reasonable in an exit event will accordingly depend on your point of view - and can also be impacted by who the stakeholder is (are they for example part of a employee stock option program, or are they held by a professional investor such as a venture lender?)
Regardless, the intrinsic model will be simpler to apply as there is no need for an additional valuation process in parallel to the negotiated price per share. Through more directly relating the warrant's value to the negotiated price per share, this approach can help reduce both the time and cost required, and also reduce the risk for litigation based on differing views on what the fair market value actually is.
Stockholm, 2023-06-05
Author: Katarina Strandberg
Most typically, such other securities will be treated the same as shares in relation to drag and tag provisions in the shareholders agreement – if the shares are sold, so are the warrants. What may differ is how they should be valued. There are good arguments for various approaches, and understanding the difference behind in particular the two most common models will be relevant when deciding what approach to take (as the bidder on the share of a company, as shareholder, or as option holder).
Intrinsic value
Firstly, you may apply the so called intrinsic value, which is when you calculate the value as the offered price per share minus the warrant’s strike price. For example;
PPS: 100
Strike: 75
Value of warrant at exit: (100 - 75) = 25
If however you are facing e.g. a distressed sale in whichthe PPS is lower than the strike price, the value will be 0 (but it can never be negative):
PPS: 100
Strike 125
Value of warrant at exit: (100 - 125 <0); = 0.
Traditional option value
Secondly, you may apply fair market value calculated through a traditional option valuation, most typically Black-Scholes, to compensate the warrant holder for the remaining time value of the warrants. For example:
PPS: 100
Black-Scholes valuation: 80
Value of warrant at exit: 80
So which one should you choose?
To begin with, as regards how the two models relate to each other the basic difference is that applying the intrinsic value will mean that the expected value/time value inherent to a warrant will be lost. On the other hand, a risk for future illiquidity - especially in a private transaction - may indicate that the expected value should be significantly lower than what only a Black-Scholes calculation indicates (due to the impact of illiquidity on the price).
What alternative that is the most fair and reasonable in an exit event will accordingly depend on your point of view - and can also be impacted by who the stakeholder is (are they for example part of a employee stock option program, or are they held by a professional investor such as a venture lender?)
Regardless, the intrinsic model will be simpler to apply as there is no need for an additional valuation process in parallel to the negotiated price per share. Through more directly relating the warrant's value to the negotiated price per share, this approach can help reduce both the time and cost required, and also reduce the risk for litigation based on differing views on what the fair market value actually is.
Stockholm, 2023-06-05
Author: Katarina Strandberg