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You are here: Home / Convertible note / What should the terms of bridge loan warrant coverage be?

What should the terms of bridge loan warrant coverage be?

May 3, 2007 By Yokum 3 Comments

1. Type of shares

Typically, the warrant is exercisable for the type of securities issued in the next round of financing. If the company has completed a Series A financing and the bridge loan is a “bridge” to the Series B, then the warrant is exercisable for Series B when the Series B financing is completed. Savvy investors will negotiate a fallback mechanism where the warrant is exercisable for an existing security (such as common or Series A) if the maturity date is reached or if there is a sale of company before the next round of financing.

2. Number of shares/warrant coverage

The number of shares issuable upon exercise of the warrant issued in connection with the convertible note is referred to as “warrant coverage.” Warrant coverage is expressed as a percentage of the principal amount of the note. Calculation of the number of shares based on the warrant coverage percentage typically means:

[number of shares issuable upon exercise of warrant] = [principal amount of loan] * [warrant coverage percentage] / [exercise price per share in the next round of financing]

So 20% warrant coverage on a $500,000 bridge loan assuming that the next round price is $2.00/share would be:

[50,000 shares] = [$500,000] * [0.20] / [$2.00]

The amount of warrant coverage seems to mimic the conversion discount range of 20% to 40%, although higher warrant coverage is not particularly unusual. The amount of warrant coverage is tied to the amount of risk that the investor incurs. Warrant coverage and conversion discounts are mechanisms to compensate the investor for risk.

3. Exercise price

The exercise price of the warrant is typically the price per share in the next round of financing. Sometimes, the exercise price may be fixed at the last round price or some other pre-determined price, especially if the warrant is exercisable for the type of security issued in the previous round or common stock.

4. Term

Most warrants can be exercised for a period of 3 to 7 years from closing of the bridge financing. 5 years is probably common.

5. Termination upon sale of company or IPO

Warrants should expire on a sale of company and probably should expire on an IPO. However, the holder of the warrant will have the ability to exercise the warrant immediately prior to these events. Warrants should expire on a sale of company because acquirors do not want to assume warrants and generally demand that warrants be exercised prior to closing. Although acquirors are willing to assume employee options in a sale of company, holders of warrants typically do not have any relationship with the company after the closing of the sale transaction.  Many companies prefer to have warrants expire on an IPO to eliminate the share overhang associated with the warrants.

Filed Under: Convertible note

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