As someone who follows a lot of small cap companies on the TSX venture, the majority of them being mining, I eventually found out about warrants.
The average investor does not know about this investing strategy.
The first thing you need to know, is that here in BC, you need to be an accredited investor. You can look up the criteria for your country/province/jurisdiction as they can vary.
If a company is looking to raise money they can do it in 4 ways:
1) Take a loan
2) Issue more shares
3) Issue bonds
4) A private placement
Each of them have their positives and negatives, but I cannot list them all. But let us focus on shares and private placements.
If a company decides to issue more shares to raise funds, it will hurt current shareholders. Why? Because they shares they are holding are now DILUTED as more shares are issued and outstanding. Not to mention the fees and expenses that comes from issuing shares.
Generally, shareholders are not big fans of this…unless the management team has a good reason.
Of course, a company may decide to do this once…but then when they need to issue more money, they will not want to issue more shares, further diluting shareholders. This is why you see some small cap companies trading for 1 cent a share with hundred of millions of shares.
Enter private placements.
A warrant is the right, but not the obligation, to buy shares at a pre-determined price for a set duration.
So you can how this is very powerful in the mining and energy sector here in Canada.
These exploration and small mining companies are not making any money, so they need to finance in order to obtain money for drilling and other projects.
They will present to the private investor and put emphasis on a catalyst for the stock price. Essentially saying “we need money to drill here, and we believe the results will be outstanding”.
If the accredited investor does his due diligence, not only will they make money on the shares, but also by exercising their warrants if the money they lent was used for a catalyst that drove stock prices higher.
Say during the financing, the accredited investors finances for 10 cents a share, with a warrant to buy more shares for 10 cents a share for up to 2 years. The money is then used by the company to drill a core sample, and a few months later, the results are astounding. The market loves it and the stock prices jumps from 20 cents to over $1. Not only has the accredited investor made money on his original shares, but he can exercise his right to buy more shares right now for 10 cents and then immediately sell them on the market for over a dollar, magnifying his earnings.
This is how it is done.
The site I use for looking for financing opportunities is http://www.canadianfinancing.com/
Mind you even if you are not an accredited investor, this information can still be helpful.
One final note is to do with hedge funds and other large institutions managing money. Generally they are not allowed to buy companies that are under $1. They would not touch these speculative mining shares. However, they can buy warrants that the accredited investor can sell. There is a market for them.
So the accredited investor can choose to exercise his warrant, or sell. Pretty much similar to options where the warrant is of course more valuable when it is “in the money”.