The right of first refusal is a common term in most startup funding rounds. So, it’s important for founders to understand what it is, how it works and how it will impact the company as it grows. This article will help you understand the concept, but every deal is different and it’s important to get advice from legal counsel on how this term will impact your deal and the future of your company. If you’re looking for counsel, feel free to reach out to us here.
The Right of First Refusal
The right of first refusal (ROFR) is a provision that allows a party (usually an investor or the company) to buy shares from shareholders before they sell them to an outside third party. With a ROFR, the holder of the right has the option, but not the obligation, to participate in any potential sale of company stock. ROFR agreements are common in startup financing.
ROFR provisions benefit both the startup and the investor. For the startup, ROFR provisions provide protection against taking on random shareholders who may not share the same long-term vision for the company as the original investor. For the investor, ROFR agreements allow them to maintain their stake in the company and potentially increase it.
ROFRs provide both parties with security and clarity, ensuring that everyone is on the same page when it comes to the sale of company stock.
How ROFRs Work
When an investor receives an offer for shares in the company from a third-party buyer. Before accepting the offer, the investor must notify their ROFR holder – either the company or preferred shareholders – and provide them with an opportunity to match that offer. The ROFR holder usually has a certain time period to consider such a purchase. If the ROFR holder decides to match the offer, then they can purchase shares in the company from the selling shareholder at the price set forth in the third-party offer.
The Second Right of Refusal
A Second Right of Refusal is a provision that allows a specific party to purchase shares from shareholders if the holder of the ROFR declines to do so. For example, if preferred shareholders have a ROFR, it is not uncommon for the company itself to have a second right of refusal. This added layer of protection helps the company safeguard itself against unwanted shareholders and take more control over its ownership structure. However, it is important to keep in mind that the Second Right of Refusal can also limit the company’s flexibility with respect to future funding rounds or strategic partnerships.
ROFR and M&A
The ROFR can have a significant impact on a startup’s ability to pursue mergers and acquisitions (M&A) opportunities. In some cases, ROFR agreements can give investors the power to block potential deals, which limits the startup’s options for finding new partners or expanding into new markets.
ROFR agreements can also make it more difficult for startups to attract potential acquirers. If an acquirer knows that an existing investor has the right to match any offer made for the company, they may be less likely to invest time and resources in pursuing an acquisition deal with the startup.
For example, if a startup receives an acquisition offer from another company, an investor with a ROFR agreement may have the right to match that offer and prevent the sale. In this case, the ROFR limits the startup’s ability to pursue potentially more strategically valuable acquisition opportunities in the long term.
While ROFR agreements can provide valuable protections for both startups and investors during funding negotiations, they can also limit a startup’s flexibility when pursuing strategic partnerships or M&A opportunities. Founders should consider all implications of any proposed ROFR agreement before signing and work closely with experienced advisors to negotiate favorable terms that support both parties’ interests. If you require legal counsel, feel free to reach out to us here.
By following these strategies, founders can negotiate more favorable ROFR agreements with investors while still protecting their own interests and promoting growth for their startups over time.