Convertible Note vs Warrants: Key Differences Explained

The main difference is who pays and when. A note holder pays up front and is owed money. A warrant holder pays to exercise later, and only if the shares are worth more than the exercise price. The table compares them on what each is, who gets it, cost, expiry, legal and tax treatment, risk, resale and a typical case.

Lenders to startups often take both a loan and warrants. The loan pays interest. The warrants give the lender a small stake in the upside if the company does well. Hercules Capital, a venture debt lender, says in its 10-K for 2025 that most of its assets are in debt structured with warrants or other rights to buy or convert.

Tax law calls a debt instrument sold together with a right like this an investment unit. The price paid for the unit is split between the loan and the warrants by their relative market values. The issuer makes the split, and holders follow it unless they disclose their own.

A $5 Million Loan with Warrants

A lender pays $5,000,000 for a loan plus warrants to buy 100,000 shares at $2.00. The parties agree the warrants are worth $200,000 on the day.

• Price given to the loan$5,000,000 − $200,000 = $4,800,000.
• Built-in interestThe loan still repays $5,000,000, so $200,000 is treated as original issue discount over its life.
• Warrant basis$200,000, which the lender adds to the cost of the shares if it exercises.

These numbers are illustrative. The point is that a warrant attached to a loan is not free for tax purposes. Part of what the lender paid is treated as buying it.

A note is debt, so its interest is income. Interest that builds up without being paid can count as original issue discount (OID), which IRS Topic 403 says may have to be reported each year with no payment. How the conversion into shares is taxed depends on the note’s terms.

A warrant you buy is an option. Buying it is not a taxable event. For a call option you exercise, IRS Publication 550 says to add its cost to the basis of the stock you bought. Warrants generally follow the same logic, so your cost basis is the warrant cost plus the exercise price.

If a warrant expires unused, 26 USC 1234 treats it as sold on the day it expired. The loss has the same character as the shares would have had, usually a capital loss. Warrants given in return for services are a different case. IRS Publication 5992 says those are taxed as pay under Section 83.

• While you hold itNote: interest or OID can be taxable each year. Warrant: nothing.
• At conversion or exerciseNote: depends on its terms. Warrant: generally no tax, and its cost joins your basis.
• If it ends worthlessNote: a bad debt, subject to its own rules. Warrant: a loss on the day it expires.

For investors, they do different jobs. A note is the main investment in an early round, with a creditor’s claim until it converts. A warrant is usually a side benefit, added to a loan or a share sale. It costs little and can expire worthless, but it can pay well if the stock rises far above the exercise price.

Employees rarely hold either. IRS Publication 5992 says options normally go to employees, and warrants typically go to outside investors. If you were paid in options, see stock options vs warrants and how to exercise stock options.

Convertible Note

For

A creditor’s claim until conversion. Interest adds to the stake. A price set later, often with a cap.

Against

All the money goes in up front. Interest can be taxed before cash arrives. Hard to sell before conversion.

Verdict: a convertible note suits an investor who wants to back an early company now and own shares later, with a lender’s protection in between. It is the investment itself.

Warrant

For

Small cost for a share of the upside. A fixed price for years. Often transferable.

Against

Worthless if the shares stay below the exercise price. No vote or dividends before exercise. An expiry date.

Verdict: a warrant suits a lender or investor who already has a main position and wants extra upside at a low cost. On its own, it is a bet that can go to zero.

If you hold a note, read the interest rate, the maturity date, the cap and the discount. If you hold warrants, read the exercise price, the expiry date and any right of the company to call them early. SPAC warrants often let the company call them once the stock trades at or above a set price, often $18.

Resale timing differs too. Shares from a converted note can count the Rule 144 holding period from the day you bought the note. Shares from a warrant count it from the warrant’s purchase only after a cashless exercise. If you pay the exercise price in cash, the clock starts again on the exercise date.

Common Mistakes

• Treating warrants as freeIn a loan package, part of the price is assigned to them, and the loan picks up built-in interest.
• Missing the expiry dateAn unexercised warrant is worth nothing after it.
• Paying cash to exercise without checking Rule 144A cash exercise restarts the holding period for the new shares.
• Forgetting dilutionBoth convert into new shares, which shrink every other holder’s stake.

Convertible note

A loan to a company that earns interest and can turn into shares at a later round.

Warrant

A right, issued by a company, to buy its shares at a fixed price before a set date.

Exercise price

The fixed price a warrant holder pays per share.

Maturity date

The date a note must be repaid or converted.

Investment unit

A debt instrument sold together with a right such as a warrant. Its price is split between the two for tax.

Original issue discount (OID)

Interest built into a debt instrument that can be taxable each year before it is paid.

Cashless exercise

Exercising a warrant or option by giving up some shares instead of paying cash.

Cost basis

What your shares cost for tax, including what you paid for the warrant.

Rule 144

The SEC rule that sets how long restricted shares must be held before resale.

Every rule was last checked on November 9, 2026. Tax rules are US federal rules. The $5 million loan is illustrative arithmetic. State tax is not covered. For how warrants compare with plain shares, see shares vs warrants.