Right Of First Refusal

In a partnership agreement, if one partner wants to sell their share to an outside party, the other partners may have certain rights. They must be informed about the planned sale and allowed to buy the share under the same conditions before the seller can proceed with outside buyers. This is to ensure that existing partners can retain control over the partnership.

This article looks into the right of first refusal (ROFR) and how this contractual right operates in various contexts.

What is Right of First Refusal (ROFR)?

Very similar to option contracts, the right of first refusal provides the holder the right, not the obligation, to take part in a transaction. The holder of the ROFR has the chance of establishing an agreement before anyone else.

For example, Sara wants to sell 1,000,000 shares she owns to Sam. Sara is offering the shares for the price of $5 million but with certain terms & conditions. However, Kevin, another investor, has the right of refusal to the purchase of shares. Sara has to offer Kevin the shares with the same terms and conditions that she offered Sam. Kevin can choose to use his ROFR at any moment within the specified time period. If Kevin decides to use his right of first refusal and goes through with the deal, Sam will have no right to strike a deal. Although, if Kevin refuses to the terms and conditions or the time period of the right expires, then Sara can freely approach Sam.

Companies or individuals commonly use rights of first refusal to view how business opportunities will be. The holder has the right to enter at a later time instead of an immediate commitment.

How Right of First Refusal Works?

The ROFR is customizable according to the parties’ preferences, enabling them to create different standard agreement variations. The agreement’s involved party can include changes such as the time period that the right will be valid for and permitting a third party that the buyer recommended to secure the purchase. Generally, the ROFR agreements are time-bound. After the time period expires, the owner can freely approach other third-party buyers.

The owner of the asset will be free to entertain others’ offers if the right holder does not want to enter into a deal. Lessees in the real estate industry often use this right as it provides them with a preference in the property that they will hold. The ROFR is beneficial to the holder of the right. But it can also be a limitation to the owner as he would have a limited number of parties interested in competing for the asset.

Applications of ROFR

ROFR can apply to various types of assets, including:

• Real estate – A tenant may have the right to purchase the property they are renting before the landlord sells it to a third party. Business
• Transactions – In venture capital, existing investors may have the right to buy additional shares before these are offered to new investors, preventing ownership dilution.
• Entertainment – In the film industry, a writer may have an ROFR on a screenplay, allowing them the first chance to produce a film based on their work.
• Family law – ROFR in family law serves as a protective measure in custody agreements, ensuring that one parent must offer the other the opportunity to care for their children before seeking alternative childcare.

As a contractual right, remedies for breach of ROFR are generally limited to monetary damages. For example, if an owner sells to a third party without offering the ROFR holder the chance to buy first, the holder can sue for damages but may find it challenging to reverse the sale.

How Does ROFR Impact the Valuation of a Company?

The Right of First Refusal can significantly impact a company’s valuation in multiple ways:

• Investor Confidence and demand – ROFR can increase investor confidence by allowing existing shareholders to maintain their ownership percentage during new financing rounds. This makes investors feel more secure knowing they can prevent dilution, encouraging them to invest more.
• Dilution Control – ROFR helps control dilution by allowing shareholders to purchase additional shares before offering them to outside investors. This makes shareholders less likely to experience a decrease in their ownership percentage and voting power. This can lead to higher valuation, especially in early-stage startups.
• Fundraising dynamics – The requirement to offer shares first to existing investors can slow the capital-raising process, as it introduces additional steps and delays. This can hinder the company’s ability to secure timely investments, potentially negatively affecting growth and valuation.
• Market Perception – ROFR signals potential investors that the company is committed to protecting its existing shareholders. This can enhance reputation and make it more attractive to investors.
• Impact on Strategic Investors – If the potential acquirers know that existing shareholders have ROFR, they may be less inclined to negotiate a deal, which could limit the company’s growth prospects and thus affect its valuation.

In short, the right of first refusal can have a dual impact on a company’s valuation. While it can enhance investor confidence and control dilution, it may complicate fundraising efforts and deter potential strategic investors.

Empowering Choices, with Right of First Refusal

In conclusion, the Right Of Refusal is an effective choice for making transactions easier while balancing the interests of buyers and sellers. By implementing its property, ROFR can enhance market stability and provide confidence to both parties in a transaction.

However, a careful study of the ROFR is important to make sure that it contains elements as imposed by law. Consultation with experts is advisable when negotiating and drafting ROFR provisions.