Sweetener

What Is a Sweetener?

A sweetener is a special feature or benefit that is added to a debt instrument, such as a bond or preferred stock, to make it more desirable to potential investors. Two popular forms of sweeteners are warrants and rights, which allow the holder to either convert securities into stock at a later date or purchase shares at below-market prices.

A sweetener is also referred to as a kicker, a wrinkle, or bells and whistles.

How a Sweetener Works

Sweeteners are especially useful for companies that are having a difficult time attracting investors or raising capital at affordable prices. A company in this position may want to conduct a standard debt offering. However, if there is not enough investor appetite to sell all of the debt, a sweetener might be required to offload the entire issue. 

Sweeteners will always cost something extra to the company giving them away, but the exact cost may not be calculable until some date in the future.

Warrants, derivatives that give the right, but not the obligation, to buy or sell a security — most commonly an equity — at a certain price before expiration, are arguably the most common sweetener offered by companies attempting to convince angel investors to invest in new financing rounds.

Warrants vs. Options

Like warrants, options are essentially contractual rights that are extended to investors, enabling them to purchase certain amounts of stock, at some future point, at prices that are agreed upon today.

Though similar in nature, there are key differences between these two derivatives. One is that warrants tend to last much longer than options — the former can last for up to 15 years, whereas the latter typically exist for a month to two to three years.

Another is who they are issued by: options are listed on stock exchanges, whereas a company issues its own warrants. In other words, that means that a company can raise additional capital from a warrant but not from options.

Example of a Sweetener

Company XYZ issues a bond to raise capital and attaches a warrant to it to make it more attractive to investors. If Company XYZ’s share price rises above the price stated in the warrant, the holder can redeem it, enabling him or her to buy stock in the firm at a price below the current market value.

On the other hand, if Company XYZ runs into trouble and its share price falls below the strike price, the holder of the warrant will not be able to cash in on the incentive it was offered. If the stock fails to recover, the warrant will eventually expire and become worthless.

Special Considerations

Warrants are prized by investors who value upside appreciation rights without requiring any up-front capital commitment. However, there are also potential downsides to these vehicles — for both parties involved.

For the companies, warrants can create uncertainty regarding the number of holders who will ultimately execute their right to exercise their warrants and acquire shares of the company. This could potentially leave companies looking to raise capital in the lurch — if holders do not exercise the warrants, the company does not get any of the cash created from issuing new shares.

Meanwhile, for investors, there is a risk of the underlying stock price climbing above the strike price to sell, or falling to below the strike price to buy, effectively making the warrant worthless. Additionally, holders of warrants do not enjoy voting rights in the way ordinary stockholders often do.