Convertible Warrants In A Series A Round?

Question: What’s your take on Convertible Warrants in a Series A round? What are the implications now and in future rounds for the entrepreneur as well as the VC?

(Jason) I like my Series A rounds to be simple. The A round is always precedent for future rounds. If you haven’t read our term sheet series, now might be a good time to start. Warrants effectively “hide” the valuation of the deal. You’ll see warrants in later round financings where the company doesn’t want to consumate a down round and instead decides to raise more money at the last financing price, but with some warrants included.

Yeah, I know, this really is a down round, as the warrants are additional benefit, but the company can say with a semi-straight face that it sold equity at the same valuation as the last round.

On a Series A deal, why play games with the valuation? Just figure out what makes sense from both sides and execute a deal? I can tell you that if I was looking to lead a Series B deal and the Series A folks had warrants, I’d make sure that I would include all of those warrants in your pre-money valuation. I’d also be pretty confused as to why this was done in the first place.

  • I agree with Jason’s comments with 2 additional items to consider where warrants might be appropriate
    1. If you have a variety of investors with different rights in the Series A, warrants can be given to early investors (such as bridge holders) that are converting into the round some advantage without creating 2 classes of stock or side agreements etc.(example bridge holders put in $1MM of stock with a 20% discount and the new investor is putting in $1.01MM but doesn’t want the voting to be swayed by the discount etc. Convert the bridge holders into the same class of stock at the same price per share and give them 20% warrant coverage.
    2. If you absolutely can’t agree on price between management and investor because there is some event in the foreseeable future, expiring warrants can act as a valuation ratchet (ex. investor get’s a warrant that makes the Series A premoney feels like $5MM unless the company exceeds a revenue target of $2.5MM for the next 12 months; without the warrant the premoney ratchets to feel like a $7MM). This can be a complex situation so I don’t advise going into it lightly
    You can’t agree on valuation today because there is a strong disagreement