Clients frequently ask us the differences between “stock options” and “warrants” and which is the right instrument for compensatory arrangements. Stock options and compensatory warrants are a great way to align the interests of a company with another individual or entity.
Of the two, stock options are more commonly used for compensatory purposes and can be issued to key employees, officers, directors, board members and other service providers. Typically, the company will have a stock option plan under which they can issue a maximum number of stock options. The issuance of stock options will be governed by the stock option plan and will usually have a vesting period, repurchase rights in the event of termination of service and other restrictions. The stock option is being used as a compensatory vehicle in order to increase an individual’s (or entity’s) overall compensation.
On the other hand warrants are not issued pursuant to any stock option plan and typically will not come with vesting restrictions. Warrants are more typically associated with investment transactions, however they can be used similarly to stock option as compensation. The typical term for the exercise of a warrant lasts longer then a stock option – it is not uncommon to see a warrant that lasts for ten years (although that is far more common with investment transactions), while a stock option will typically have a much shorter exercies period. While a warrant can be used for compensatory purposes, it is important to note that a compensatory warrant will likely be taxed just like the compensatory stock option, while a investment warrant will have far different tax implications).
In short, stock options and warrants can both be used for compensatory purposes, but it is far more common to issue stock options under a stock options plan. The differences are largely superficial and can be minimized by drafting either document to suit your company’s needs. Before deciding which instrument is right for a company it is important for both the company and the recipient to consult its attorney and tax advisor.