The 2020s have provided a landscape for historic changes in financial markets. Rollercoaster market movements, meme stocks, ultra-low interest rates, crypto, FAANG, asset bubbles, and more. With all the excitement, millions of new ‘retail’ (non-professional) investors entered the arena, and billions worth of capital was deployed by investors of all types.
Now, as interest rates and inflation are rising, global economic and political conditions are more precarious. Will investors stick with the companies they were oh so excited about not too long ago? A concept with exclusivity, value, and the potential to influence investors’ decisions is that of a ‘Loyalty Option’. But does a Loyalty Option mean actual loyalty?
What’s a Loyalty Option?
Options, as a financial instrument, give investors the right but not the obligation to buy or sell (for this explanation, shares) at a specified price before an expiry date. Essentially, I have a piece of paper that says I can buy X number of shares at $X until date xx/xx/xxxx.
“Loyalty Options” are marketed as a way for companies to reward ‘loyal’ shareholders. They act in the same way as regular options but are only open to current shareholders of the company, making the offer exclusive (more on this later).
Typically, investors will pay a small fee for a regular option. Flexibility to choose whether to buy shares at the pre-determined price in the future is itself valuable. For Loyalty Options, this fee is usually reduced or waived. A nice benefit for shareholders.
Why issue Loyalty Options?
The company needs money. The two basic choices are to get a loan or give away ownership in the company. For the latter, the company could open this opportunity up to everyone, or they could make it exclusive. One application of this is offering a Loyalty Option.
There’s a strong business argument for maintaining steady, long-term shareholders rather than short-term, market-influenced shareholders. It reduces stock price volatility and the risk of major stock sell-downs in a poor economic environment. Both of which executives would like to avoid.
From a marketing perspective, it’s a chance for companies to say how much they appreciate their shareholders. However, eligibility is based on share ownership at a ‘record date’, which is usually about 5 days after the announcement of the Loyalty Options. This provides a window of opportunity for ‘non-loyal’ shareholders to get in on the action. For this reason, it’s debatable whether a Loyalty Option is actually a gesture of appreciation to loyal shareholders.
Case Study: Incannex Healthcare
Incannex Healthcare is a medical cannabis company that is aiming to commercialise sophisticated cannabinoid and psychedelic medicines for prescription, or administration, by health professionals. In early 2022 they announced a Loyalty Options scheme whereby Australian and New Zealand shareholders were eligible to take advantage of the offer.
Quote from Joel Latham (CEO & Managing Director of Incannex Healthcare), “The loyalty option is intended to reward our loyal shareholders whilst simultaneously assisting Incannex with the funding requirement for the next phase of development …”.
For every 15 shares held as of 23 March 2022, shareholders were issued with one free loyalty option. Between the time of issue and 22 April, one month later, these shareholders had the option to convert their Loyalty Options to real Incannex Healthcare shares at a price of 35 cents. At the time these shares were trading at 66.5 cents, a hefty discount of 47%.
Interestingly, the company included a ‘piggy-back’ option for anyone who exercised the first batch of Loyalty Options, perhaps playing into the loss aversion bias. The piggy-back option was issued at the ratio of one for every two original Loyalty Options used. Shareholders can convert these piggy-back options to Incannex Healthcare shares before 28 April 2023 at a price of $1. The $1 price tag is a lot higher than the 35 cent Loyalty Options or the market price of 66.5 cents at the time, however, the holder of these options has until the expiry date in April 2023 to decide and the market price could rise in that time.
Here are some other examples of recent Loyalty Options issues.
What does it all mean?
Whether these Loyalty Options induce loyalty in their current form is questionable. At the moment, these financial instruments help companies who are struggling to find sources of funding elsewhere, The ‘Loyalty Options’ naming convention puts a marketing spin on it, and allows management to gush about how much they appreciate their shareholders.
There is plenty of room for innovation in this space because long-term shareholders aren’t necessarily rewarded for their loyalty, beyond the possibility of positive financial returns. Reducing stock price volatility and avoiding large selloffs during downturns are desires of all corporate leaders. Therefore, these valuable shareholders should be rewarded for sticking with the company – profits or not.
Imagine a tiered structure based on ownership tenure with a heavier share price conversion discount applied to the Loyalty Option all the way down the line. In this model, when a company requires funds, they are offering loyal shareholders a piece of the action rather than reaching out to other big banks.
Providing these exclusive benefits to shareholders could be a small price to pay for a resilient and loyal investor base.
