Warrants and Covenants in Venture

Most founders experience venture rounds as incremental. More capital, more dilution, more board seats. What often changes more meaningfully than the check size is the terms of the capital that comes with it. As companies move beyond early-stage rounds, venture financing begins to borrow tools from credit markets. Warrants and covenants are two of the clearest indicators of that transition.

They are rarely talked about, and most founders enter these conversations ill-equipped. Warrants are positioned as a small enhancement to investor economics. Covenants are described as standard governance. In reality, both terms meaningfully change how risk, upside, and decision-making are distributed inside the company. As we wrote about last week, these dynamics matter less at seed and much more once rounds become larger, outcomes narrower, and timelines more visible.

Warrants: Additional Upside Without Additional Capital

A warrant gives an investor the right to purchase shares at a fixed price in the future, typically at the price of the current round. Warrants almost never appear in seed or Series A financings. They become common in later-stage rounds, venture debt, structured growth financings, and bridge or any pre-IPO rounds. The common thread is not company quality, but investor posture. Warrants show up when capital is more focused on downside protection and return enhancement than on pure growth exposure.

From the company’s perspective, warrants can feel harmless. They do not change the headline valuation and they do not create immediate dilution. From an investor’s perspective, they materially improve expected returns by adding option-like upside without committing more capital. That asymmetry is intentional. If the company underperforms, the warrant expires worthless. If the company succeeds, the warrant converts into real ownership.

Founders often underestimate warrants because the dilution is deferred. But future dilution is still dilution. Warrants lower the effective price investors are paying and increase the fully diluted ownership they receive at exit. As we wrote about last week with liquidation preferences and participation rights, later investors, bankers, and acquirers will model this explicitly even if the original term sheet did not emphasize it.

Covenants: Constraint Through Contract

Covenants operate very differently. Rather than shaping economics, they shape behavior. Covenants are contractual commitments that require the company to do certain things or restrict it from doing others without investor consent. They exist in early rounds in limited form, but they become more detailed and restrictive as companies raise later-stage or structured capital. In venture, covenants follow a staircase of complexity. As the checks get bigger, the rules get tighter.

Negative covenants limit actions such as raising additional capital, taking on debt, pursuing acquisitions, or changing strategy without approval. Affirmative covenants require ongoing reporting, budgeting discipline, or operational commitments. Financial covenants, which are rare in early equity rounds, introduce explicit performance or liquidity thresholds and are common in venture debt and hybrid equity structures.

As we wrote about last week in the context of protective provisions, control is not exercised only through boards and voting power. It is exercised through consent rights embedded in legal agreements. These constraints can slow decision-making, complicate fundraising, and reduce a founder’s ability to respond to changing conditions, particularly when performance deviates from plan.

Why These Terms Appear Together

Warrants and covenants often appear in the same rounds because they serve complementary purposes. Warrants increase upside participation. Covenants reduce downside risk. Together, they move the investment profile closer to a credit-style structure while preserving equity-level returns.

This is not inherently bad. In some cases, it is the only capital available. The issue is that these terms change incentives in the same way stacked preferences do, as we wrote about last week. Moderate exits become less attractive to investors with layered upside protection. Operational flexibility narrows as more approvals are required. Founders may retain formal authority while finding that meaningful decisions require external consent.

As with preferred rights, these terms compound. Once introduced, they are difficult to remove. Later investors rarely accept weaker protections than those already in place, and founders negotiating under time pressure often lack leverage to reset them.

What Founders Should Pay Attention To

The presence of warrants and covenants signals a change in how investors are underwriting the business. Founders should evaluate these terms with the same rigor they apply to valuation. How much ownership do warrants represent at realistic exit values. Which decisions require consent during periods of stress rather than growth. How these terms affect the next round, not just the current one.

Later-stage venture financing is less forgiving than early rounds. The contracts reflect that reality. Warrants and covenants are not secondary details. They are how capital expresses what it values, what it fears, and how much control it expects in return.