The warrants definition is the right to purchase shares or bonds at a fixed price before there is an issuance in the public marketplace. In this sense, a warrant is like a call option. But there are several key differences.
Warrants are often used in finance and investing to make a deal better or provide a premium to potential investors in the company. The ability to buy an asset at a fixed price is a huge benefit if the price is higher because an investor can instantly see a profit. Like options, they expire after an allocated amount of time has passed. However, a warrant expiration could be years in the future as opposed to months, which is common for options.
Another large difference between warrants and options is that a warrant grants the right for an investor to buy stock or bonds before they are issued to the public market. This is why many private equity holders contain warrants. If the company has been a successful venture and is ready to issue an IPO, then the private equity holders have the ability to buy stock before the issuance. This right is a huge benefit if an investor sees a company with great potential. As a result, the investor can turn a huge return on investment.
For example, Wawadoo Co. is a private company that is looking for investors to fund its newly developed product known as the widget. Widgets are considered the future in the market. And Wawadoo believes they will be a huge success. To incentivize private equity holders, Wawadoo has attached stock warrants in relation to the amount of money invested. The warrants have a life of five years. After three years, the widget has been such a success that Wawadoo is ready to enter into the public marketplace by offering an IPO. As this is happening, the private equity group has exercised its warrant. Thus, Wawadoo must honor the warrant. So, they provide the equity group a stake in the newly offered shares in the market before the actual IPO.