Many Golden Returns

Fire When Ready

Truth be told, in our example, it's unlikely the investors have gotten any less cagey or any more confident in the intervening two years, even though the company has performed. Sure, they can buy $5 stock for $2, but only in theory, unless it's a public company. As a result, most warrants have some kind of mechanism allowing the entrepreneur to pull the trigger, so to speak, and get the investors to exercise their option to buy more shares.

This trigger mechanism is often called a "redemption feature," and it works like this. In addition to giving investors the right to purchase additional shares, warrants offer the company the right to buy the warrants back from the investors, often for just a few cents. So in the case of our hypothetical venture, here's how it might play out.

At the point in time when the company's shares are well above the exercise price, the company will notify the shareholders of its intention to redeem the warrants, say, for a penny per warrant. Now investors have a choice to make. Ante up another $2 per share to stay in the game and realize an immediate $3, or 150 percent, gain, or check out and receive just a penny per warrant. Three dollars vs. $0.01. Faced with that hard choice, most investors will exercise their warrant, or at least the company hopes so.

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This article was originally published in the March 2000 print edition of Entrepreneur with the headline: Many Golden Returns.

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