Right of First Refusal (ROFR): Company’s Option to Buy Back

A Right of First Refusal (ROFR) gives the company and/or other investors the opportunity to step in and buy shares before they’re sold to an outside party. Think of it as a “first dibs” policy. It’s a common mechanism in private company investing, designed to maintain some control over who owns the company’s equity.

How a ROFR Works:

Let’s say you want to sell some of your private company shares. Before you can finalize the sale to a third-party buyer, you typically have to notify the company (and sometimes other designated parties) about your intent to sell, including key details like the number of shares, price, and the prospective buyer. This notification triggers the ROFR.

The company then has a window of time (typically specified in the shareholder agreement) to decide whether to exercise their right. They have a few choices:

• Match the Offer: The company can buy your shares at the same price and terms offered by the outside buyer. This effectively replaces the original buyer with the company itself.
• Partial Match: Sometimes the company or other investors might choose to buy only a portion of the shares you’re offering.
• Waive the Right: If the company isn’t interested or can’t afford to purchase the shares, they can waive their ROFR, allowing you to proceed with the sale to the original third-party buyer.

Why Companies Use ROFRs:

• Control Ownership: ROFRs help companies control who becomes a shareholder. They can block undesirable investors or maintain a certain ownership balance.
• Consolidate Ownership: They can use a ROFR to repurchase shares and thereby consolidate ownership amongst existing shareholders.
• Protect Strategic Interests: This can be particularly important if the potential buyer is a competitor or poses a risk to the company’s business strategy.

Why ROFRs Can Be Tricky for Sellers:

• Delays: The ROFR process can add time and complexity to a sale. It can also be a source of friction if a deal is time sensitive and the ROFR period is long.
• Discouraged Buyers: The presence of a ROFR can sometimes deter potential buyers, especially if they don’t want to go through the hassle of due diligence and negotiations only to have the company step in and buy the shares.
• Price Uncertainty: While a ROFR guarantees a minimum price (the third-party offer), it can create uncertainty if the seller believes they could get a higher price without the ROFR in place.

The Bottom Line:

ROFRs are a common feature in private company investing, reflecting a balance of power between companies and shareholders. Understanding how they work is essential for both parties involved in a secondary transaction. If your shares are subject to a ROFR, be sure to review the details in your shareholder agreement and consult with a financial advisor if you have questions.

So here’s what we covered:

• Definition of a Right of First Refusal (ROFR)
• How a ROFR works in practice
• Reasons why companies use ROFRs
• Potential drawbacks of ROFRs for sellers
• Importance of reviewing your shareholder agreement

Learn More: Shareholder Agreement Learn More: Secondary Market Learn More: Selling Your Shares with Earlyasset