Tech SPAC Redemption Rates
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“What will the redemption rate be?” is a common question in discussions between private companies and SPACs. The answer to this question is a function of a number of factors, with the three most important being market sentiment, company valuation, and shareholder rotation. There is certainly some overlap and interaction between these factors, but let’s look into them individually to help clarify things.
Background
A feature of the SPAC structure is that shareholders can elect to redeem their shares about a week before the SPAC reverse merger transaction closes. This redemption deadline is the point where a shareholder may elect to exchange shares for the approximately $10 per share held in trust from the SPAC’s initial IPO. The exact amount can be a few cents higher than $10 per share due to interest earned on the money held in trust, and it can be ten to twenty cents higher if the SPAC sponsor had to overfund the trust in order to get the initial IPO completed. For simplicity, I’ll refer to “$10 per share,” but it should be taken to mean the exact amount of cash in trust per share.
Market Sentiment
There has been something of a pendulum swing from higher redemption rates in early 2020, to low rates in the first half of 2021, back to high rates in the second half of 2021. In 1H 2021 there was high demand in the public market for early stage companies (many pre-revenue) that projected large and profitable businesses a handful of years out into the future. Statistically speaking, most pre-revenue companies fail to live up to their expectations for growth. They may still be good investments in aggregate, driven by a few eventual big winners, but on a count basis, there will be more disappointments than successes. And those disappointments will reveal themselves sooner than the big winners can. In the middle of 2021, some of this statistical reality — along sadly with some abuses of the SPAC structure — became apparent, and redemption rates climbed.
In 2H 2021, 124 SPACs were closed, across all sectors, all sizes, and all geographies (excluding the small number of SPACs focused on niche geographies, which tend to behave differently). For those 124, the Average and Median redemption rates were 56% and 66%, respectively. I’ll focus my analysis on the Technology subset, but note that it has similar redemption statistics as the others. In 2H 2021, the 35 Tech SPACs that closed had Average and Median redemption rates of 58% and 69%, respectively.
Company Valuation
The private company and SPAC sponsor work together to come up with a proposed valuation for the private company. This manifests itself in the number of $10 SPAC shares that are allocated to the existing shareholders of the private company. This proposed valuation gets a true arms-length investor test at one (or more) of four times in the process: (i) if the SPAC sponsor is buying a substantial number of shares with money beyond the money in the SPAC trust account, (ii) in the raising of a $10 per share common equity PIPE before the SPAC redemption deadline, (iii) in the trading of the SPAC’s public shares above $10 per share in the time between the transaction announcement and the redemption deadline, and/or (iv) near the end of the SPAC process at the redemption vote. If any of the first three are present in a meaningful and convincing way, they should have a positive impact on the redemption vote. And the way they manifest themselves is in the share price of the SPAC shares trading in the public market.
As the redemption date approaches, a shareholder has three options: (1) hold the stock and let it “convert” into shares of the post merger new company, (2) sell the shares in the market, or (3) elect to redeem the shares for $10 of cash per share. Obviously, if the shares are trading for more than $10 apiece, very few shareholders will opt to redeem their shares — they either plan to hold them through the “conversion” into the new company, or would sell them for more than $10 per share in the market. Every share that gets redeemed is $10 that does not get put onto the company’s post-transaction balance sheet. It is also one less share outstanding, which reduces dilution for the previous shareholders of the private company.
The share price chart below shows the case of a specific SPAC that had a high (above 90%) redemption rate.
Before the announcement of the proposed merger, SPAC shares are generally held by risk-free-yield seeking investors with little intention of being long term holders (ie, beyond the redemption deadline) of a yet-to-be-named specific operating company. At the announcement date, information is shared publicly about the transaction details, including specifics of any SPAC sponsor investment beyond the cash in trust and any PIPE investment, along with details from the then-private operating company. If the trading price and volume (more on this below) are low, this suggests that public market investors are underwhelmed by the deal and the redemption rate will be high.
It is important to note that because the shares can be exchanged for $10 apiece at the redemption deadline there is significant price support for the shares not to fall too far below $10 per share, no matter how overpriced the transaction may appear in the stock market’s collective opinion. If a SPAC’s shares fell to say $9.00 apiece in the time before the redemption, there would be a risk-free opportunity to make $1.00 per share by buying those shares and redeeming them for $10 in a few months time. Because of this, SPAC shares rarely trade at more than a handful of percent discount to $10 per share.
The share price chart below shows a case for a specific SPAC whose redemption rate was very low (below 10%)
In the case above, in the time between announcement and redemption, we see most of the trading done at above $10 per share. This gives ample opportunity for the risk-free-yield seeking investor to sell their positions to those investors who want to be longer term holders of this particular company.
Looking at this behavior across all 35 of the Technology SPACs that closed in 2H 2021, we see the plot below. Here, I only consider whether or not the share price at the close before the redemption deadline (usually after markets close on a specific date) was above the cash in trust. Even with this simplistic measure of the market’s assessment of company valuation, we see a strong correlation with subsequent redemption rates. An R-Squared of 0.34 is consistent with a statistically significant correlation. Individual cases can be complicated by situations such as a SPAC that has extended their original deadline before the redemption date. In this situation, the shareholders have a redemption option at the original SPAC deadline date, which may have been exercised before the ultimate reverse merger prospect is even identified. Despite these types of complications, the plot below shows the behavior one would expect: transactions that value the private company too highly in the market’s opinion see high redemption rates.
Shareholder Rotation
After the proposed reverse merger with a SPAC is announced, through to the time of the closing of the transaction, the management of the private company and the SPAC sponsor team meet with analysts and potential long term investors to share their story. The fact that these can happen over a several month period of time vs the couple of weeks of a traditional IPO roadshow is one of the ways that a SPAC path to being public is meaningfully differentiated from the traditional IPO path. This allows potential long term investors time to do their analyses, and if convinced that it represents a good investment, establish positions via purchases of the SPAC shares that become shares of the new merged entity after the close. Therefore, trading volume between the announcement date and redemption date is another key predictor of redemption rate.
Looking at the same 35 Tech SPACs closed in 2H 2021, in the plot below, we see the strong correlation between the trading volume in the announce to redemption date period and the subsequent redemption rate. This is another statistically significant correlation (and separately confirmed to be independent of the Share Price correlation above). This highlights the importance of a well-orchestrated investor and analyst outreach program starting with a well formed process around the announcement.
Conclusion
While SPAC redemption rates are not completely deterministic, they are fairly predictable. Public sentiment can change between the time of announcement and the redemption deadline. But, an attractively priced transaction, followed up with a well managed analyst and investor outreach program, has a high probability of achieving a low redemption rate.
Subsequent to writing this post, I wrote a post examining the correlation between redemption rate and stock price performance after the deSPAC is closed: Impact of SPAC Redemption Rates on Subsequent Share Prices.
