Warrants

An alternative way to give bondholders an opportunity for additional returns when the firm’s common shares increase in value is to include warrants with straight bonds when they are issued. Warrants give their holders the right to buy the firm’s common shares at a given price over a given period of time. As an example, warrants that give their holders the right to buy shares for $40 will provide profits if the common shares increase in value above $40 prior to expiration of the warrants. For a young firm, issuing debt can be difficult because the downside (probability of firm failure) is significant, and the upside is limited to the promised debt payments. Including warrants, which are sometimes referred to as a “sweetener,” makes the debt more attractive to investors because it adds potential upside profits if the common shares increase in value.