Inflationary Pressures Drive SPAC Redemption Rates Higher: Investors Vote with Their Feet

Editor's Note:Daniele D'Alvia is the CEO of SPACs Consultancy LTD and a Teaching Fellow in Banking and Finance Law at the Centre for Commercial Law Studies, Queen Mary University of London. The views expressed in this article are solely those of the author.

Redemption Rate Anomalies: Data Reveals a Shift in Investor Behavior

Under U.S. Securities and Exchange Commission (SEC) rules, special purpose acquisition companies (SPACs) are not permitted to disclose their merger targets at the time of their initial public offering (IPO). To entice IPO investors to lock their funds in a trust account, SPACs typically grant investors the right to redeem their initial investment as compensation for the waiting period.

However, in the last two quarters, the rate at which investors have withdrawn funds from SPACs has risen significantly. Data shows that only about 10% of investors exercised their redemption rights in the first quarter of this year, while the redemption rate climbed to over 25.1% in the second quarter. Comparing the quarterly average redemption rate with the annual average redemption rate clearly reveals this significant change.

Inflation and External Shocks: Macro Drivers of Redemption Behavior

Since the onset of the COVID-19 pandemic, average inflation levels in the United States have risen sharply. Federal Reserve data shows that the inflation rate climbed from 1.9% in 2019 to 4.2% in early 2021. When inflation is on an upward trajectory, public market investors often show a greater tendency to choose redemption. This phenomenon also appeared in 2019—when the Federal Reserve reversed its policy normalization process, and an inverted yield curve heightened the threat of an economic recession. Meanwhile, tensions in the Middle East led to attacks on oil tankers in the Gulf of Oman, causing oil prices to surge and production to temporarily drop by more than 50%. In December of that same year, then-President Trump became the third U.S. president in history to be impeached.

SPAC investors are no more or less sensitive to financial news and external events than any other investor in the financial markets. In the face of inflation, investors need liquidity. For them, what better option is there than redeeming their SPAC shares at a nominal value of $10 per share plus the accumulated interest in the trust account?

Evolution of Governance Structures: Redemption Rights Expanded to 100%

However, rising redemption demand is not solely explained by inflation. Looking back at the evolution of SPAC governance structures: before 2015, SPAC redemption rights were typically limited to a portion of the initial investment (around 85%), and could only be exercised upon liquidation or when investors voted against a proposed merger (i.e., a de-SPAC transaction).

Starting in 2015, typical SPAC terms were significantly relaxed, granting investors the right to redeem 100% of their initial investment (plus interest) upon liquidation or business combination, regardless of whether they voted for or against the transaction. In fact, SPACs often allow IPO investors to retain their public warrants after redeeming their public shares (the so-called "SPAC 3.0" model).

This means that investors can redeem their shares while still holding their warrants, hoping to purchase shares of the newly combined entity at a discount after the business combination is completed. Of course, this all presupposes that the new stock price can reach the warrant's exercise price of $11.50 per share; otherwise, the warrant would be out-of-the-money.

This institutional design provides another important perspective for understanding the current high redemption rates in the SPAC market.

Not a Bubble: The Logic of Rational Risk Avoidance

Some argue that we are witnessing the bursting of a long-awaited "SPAC bubble." But as financial crisis historian Charles Kindleberger noted, mania often accompanies economic booms, when money seems readily available. That is clearly not the case now—in a period of recession and high inflation, the time value of money is highlighted, and opportunity costs are squeezed by higher and more diversified discount rates. In this context, exercising redemption rights is the only rational choice to address liquidity shortages and avoid risk. We are far from a frenzied SPAC bubble.

Looking back at history helps clarify the current situation. On October 25, 2019, Virgin Galactic announced a business combination agreement with Social Capital Hedosophia. This kicked off a series of high-profile deals where private companies "went to space" through SPACs. However, few remember that at that time, 12,106,110 investors chose to redeem shares from Social Capital Hedosophia Holdings Corp., which meant a reduction of $125 million in the trust account.

The redemption volume at that time was higher than expected, resulting from the combined behavior of two types of investors: one group of SPAC investors waited too long, hoping the stock price would rise further; another group of long-only investors waited for the merger to complete to realize gains. Trying to profit from a business combination is normal behavior, but holding shares of a SPAC trading below its net asset value is foolish and reckless.

Frank Sinatra once sang: "That's life." And in the SPAC world, that phrase sounds no different from "That's SPAC." The economic environment is not as rosy as it appears on the surface, so, "That's SPAC!"—investors are exercising their redemption rights.