TL;DR: The exercise price (also called the strike price) is the fixed price at which a warrant or option holder can purchase shares. In venture debt, the exercise price on lender warrants is typically set at the share price from the most recent equity round. Warrants only have economic value if the company's share price at the time of exercise exceeds this fixed price.
The exercise price is the pre-agreed price per share at which a warrant holder has the right to purchase equity. It is set at the time the warrant is issued and does not change over the life of the warrant.
In venture debt, lenders receive warrants with an exercise price usually pegged to the company's last financing round. If a company raised a Series A at a$10/share price, the lender's warrants may carry a $10 exercise price.
Warrants are worth exercising only when the current share value exceeds the exercise price. A warrant with a $10 exercise price is worth exercising if shares are trading or valued at $15; the lender buys at $10 and realises a $5 gain per share. If the share price never exceeds $10, the warrant expires without value. This means warrant dilution is conditional on value creation: founders only experience the dilution if the company has grown.
Warrants are typically exercised cashless at a liquidity event. No cash changes hands, the lender receives shares equal to the gain in value (the spread between the exercise price and the current share price), rather than paying the exercise price in cash.
True dilution from warrants is generally calculated on a net "cashless" exercise basis. This means the actual dilution you experience is based on the economic value the lender gained, not the gross number of warrants issued. In a cashless exercise, the lender doesn't pay cash to buy the shares. Instead, the total number of shares they receive is reduced to account for the strike price.Because of this mechanic, dilution is driven by the spread between your exit price and the strike price. Consequently, a venture debt facility with a higher headline warrant coverage but a high strike price can actually result in less final equity dilution than a facility with lower coverage but a lower strike price.
Can the exercise price be negotiated? Yes. While it is commonly set at the last round price, founders and lenders can negotiate the reference price, particularly if no recent financing has occurred.
What happens to warrants with a high exercise price in a down round? If the company raises equity at a lower valuation than the exercise price, and if the warrants’ strike price is fixed, then the warrants are underwater, worth nothing to the holder unless the share price recovers above the exercise price before expiry.
Related terms: Warrant · Dilution · Cap Table · Venture Debt
