IFRS 9/ IAS 32 - Penny Warrants

[Brains12]

Hello,

A company acquired 10% of a Target. To increase its returns, the Acquirer received also some penny warrants (exercise price of one cent) which give the option to buy additional X shares after 3 years from financial close.

Can those penny warrants be classified as derivatives?

1. The settlement is at a future date.
2. Warrants change in value in response to movements in Target’ share.
3. They require no initial investment.

The answer seems yes. However, the fair value of penny warrants is basically equal to Target’s shares at inception. It seems a prepaid forward sale of equity to me and not derivatives.

Can I classify them as an equity instrument (fix cash for fix number of shares) instead as derivatives? This is preferable to me, because I would avoid calculating the warrants’ fair value periodically for three years. The Target is private and the share price is not easily available.

Can you please help me on this?

Thank you

[JRSB]

are there any conditions other than waiting 3 years? otherwise it does seem like free shares given in 3 years' time. do you hold that 10% interest at fair value?

[Brains12]

Yes, there are other conditions. Warrants can be exercised also if there is a down-round or a change in control before the 3 year period.
Yes, the Acquirer holds the 10% at FV and the warrants are expected to give an additional 3% ownership percentage.

[Marek Muc]

To me, these warrants aren't like free shares because they don't come with voting or dividend rights. If you're holding a 10% stake in that company, it falls under IFRS 9, meaning you've got to reassess the fair value of the shares at each reporting date anyway. If you prefer to keep it simple and the investment isn't too significant, you might want to work out the fair value of the warrants by deducting the present value of expected dividends from the fair value of the shares.

[Leo]

It looks like a derivative, it hinges on whether you will get a fixed number of shares on conversion for a fixed amount. I think the warrants should be treated separately.