Warrants + Independent sponsors = 💔
A warrant is like a stock option, giving lenders the right to convert a portion of the loan into common equity at a pre-specified price. For example, SBIC lenders often propose warrants that convert into 5-10% ownership.
For high-growth, early-stage, VC-style companies, warrants are cheaper than equity and align lenders with the upside potential.
However, warrants are unnecessarily dilutive to the investors in independent sponsor deals, and thus more expensive than a plain debt solution.
Sponsors may like the lower coupon and the idea that dilution only materializes in the upside. But it's almost always cheaper to pay a slightly higher rate and protect the equity.
Either way, make sure to disclose any warrants to your investors so they don't subscribe unknowingly.
Ian Reynolds lays it out in Ep35 of the Minds Capital Podcast.
