Making the most of Performance-based Warrants

Background

Why Performance-based Warrants?

  1. Beta Customer (Symbiotic) — In this instance, the customer you are incentivizing is a very early (beta) customer, potentially a marquee name and someone who can help you shape the product and influence other customers in that segment to adopt your solution. The customer benefits from early access to the startup’s technology, while the startup gains implicit or explicit endorsement from the large customer. The “stamp of approval” could be sufficiently valuable to a startup and granting Warrants for joint marketing or other promotional activity could be a good way to align interests.
  2. Buyer and Reseller Relationship — In situations like this, a Partner is both a buyer and reseller of the startup’s products. Performance-based Warrants can be a way to reward and incentivize the partner for achieving certain sales targets. When it works well, the startup gets more revenue, and the partner gets to participate in the upside from the startup’s success.
  3. Financing Options — When a startup funding round is not big enough to accommodate a strategic investor’s minimum investment amount or percentage ownership requirements, performance- or milestone-based Warrants could be one way to address that gap. For example, if the strategic investor has a $3M minimum investment threshold and only $2M of the round is available, the parties can agree on a mutually agreeable performance-based warrant structure that requires the strategic investor to deliver the value promised by it. Such a financing structure aligns incentives and potentially balances the dilution with the value accrued by the startup.
  4. Warrants for Services — it is not uncommon for startups to issue Warrants to Partners or other Stakeholders who provide services to a startup. For example, a startup may grant Warrants to an incubator or accelerator in what is essentially an exchange of services for potential equity. Accelerators could be providing facilities, infrastructure, admin support, cloud credits, talent or other things a startup is lacking, in exchange for Warrants. Similarly, Warrants could be issued to a strategically important partner, who may not have a venture capital arm or the capacity to make a direct equity investment, in exchange for signing an OEM agreement or licensing IP that may prove valuable in the long run.
  5. Bank Warrants — it is not uncommon to see Warrants associated with a Venture Debt agreement. When lenders issue debt to startups, they frequently tradeoff the interest rate or other payment terms for Warrants.
  • Pre-money Valuation Adjustment — Although uncommon now, we have seen investors seek Warrants to reduce the pre-money valuation if the management team does not hit revenue targets or operational milestones contained in the investment prospectus. This is effectively the opposite of aligning interests and not a recommended or effective use of Warrants to address valuation gap during a financing round.

Vesting Triggers

  • A specific number of customer introductions — It is important to identify the set of customers and the introduction criteria that triggers the vesting process. In addition, a timeline by which such introductions should be completed is an important consideration.
  • A specific number of POCs (proof of concept) delivered to potential customers — This rachets up the above trigger, forcing a partner to do more than just enable a foot-in-the-door.
  • Specific impact on Revenues or Bookings — An effective and meaningful trigger is to set a target for top-line value creation, wherein a partner contributes a certain dollar figure of revenues or bookings.
  • Geo-market Expansion — If you’re looking to make inroads globally, you may want to piggyback on your partner’s global presence. Consider targeting a certain amount of bookings generated in a region, like Asia Pacific or Latin America, where you don’t have direct presence.
  • No warrants vest until the Service Provider meets ½ the requirements of the agreed milestone. Such a structure ensures that the Partner needs to meet a certain threshold (Floor) before reaping the earning the warrants.
  • 50% of the warrants vest only after ½ the milestones are met
  • After this, warrants vest linearly until all milestones are met
  • There is a cap at 100% (Ceiling), i.e., no additional warrants are issued after all milestones are met

Conclusion

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Wipro Ventures bridges the gap between emerging startups and enterprise customers. Established in 2015 as the strategic investment arm of Wipro Limited.

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Wipro Ventures

Wipro Ventures

Wipro Ventures bridges the gap between emerging startups and enterprise customers. Established in 2015 as the strategic investment arm of Wipro Limited.

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