How redemptions rights protect investors in SPACs
How redemptions rights protect investors in SPACs
2020 saw SPAC prices rise in a great wave of euphoria, but they have since come back to earth, with many trading below their $10 IPO prices. This year’s declines have prompted concerns that SPACS are a bad deal for retail investors, or that those investors are somehow being taken advantage of.
A look under the SPAC hood reveals the reality is quite different. SPACs are structured specifically to offer investor protections through several features, among the most important is their redemption right. They also provide investors with the opportunity to sell their shares if they chose to do so at many points along the way. In some cases, investors can make a modest profit without taking much risk. How many other investments offer the same features?
Let’s start at the beginning. SPACs raise money through an IPO with units priced at $10. The money is put into a trust and invested in US Government guaranteed securities, almost always in T-bills. The SPAC sponsors then have up to two years to find a target company. If they don’t, investors get back their $10 – plus any accrued interest. If the sponsors do reach a deal to buy a business, they must submit details of the proposal to the Securities and Exchange Commission for review. During this time, investors can assess the deal and decide if they like it. When the SEC clears the proxy – meaning all questions and comments presented to the issuer by the SEC have been addressed by the issuer; the SEC does not endorse the investment or proposals contained within the proxy – it is mailed to shareholder for their approval of the proposed transaction. Typically, that vote comes about four to six months after the acquisition was announced. At the time of the vote, any investor can still decide not to participate and elect to redeem at $10 plus any accrued interest. If you want an analogy, it is a bit like taking a car out for a months-long test drive. If you like it, you can keep it. If not, you get your money back, no questions asked.
A chance to come out ahead
In the current environment, in a bid to entice investors, some SPAC sponsors are offering additional features----kicking in an extra 10 or 20 cents per share of their own money to overfund the trust. In these cases, should an investor choose to redeem, they would get back the original $10 plus the extra 10 or 20 cents. In today’s low-rate world, the SPAC becomes a nice alternative to buying T-bills.
SPAC investors also have a chance to make money with the components underlying the unit, securities issued at the time of the IPO that give an investor an opportunity to buy shares at a fixed price for some period of time. An investor can choose to sell or redeem their shares but retain the warrants, creating a unique way to reduce downside risk while preserving some upside. If the SPAC makes a successful acquisition, those warrants could have value down the road.
In the end, if an investor chooses to stick with the SPAC, they are in the same position as the holder of any other stock, with one key difference: they have had plenty of time to think about it and an ongoing opportunity to liquidate their investment.
The SPAC market is working
The weak performance of many SPACs this year, coupled with rising redemption rates, has led some to conclude that the product is flawed or that the market for SPACs is broken. Again, those are misperceptions shaped by the comparison to last year’s euphoria. Savvy investors are evaluating SPACs and deciding which ones have attractive prospects and which ones don’t.
Ultimately, rising redemption rates don’t indicate SPACs are broken; rather, they reflect that investors are taking advantage of the unique protections SPACs are designed to provide.
Like all investments, SPACs come with risks. But the protections afforded by redemption rights limit those risks and provide a welcome measure of safety for all SPAC investors, including retail investors.