Right of First Refusal

Definition

The right of first refusal (ROFR) is a contractual agreement that gives an individual or entity the opportunity to purchase an asset before the seller can offer it to others. This term is crucial in equity considerations and deal terms as it provides existing stakeholders, often investors or partners, the chance to maintain their ownership percentage and avoid dilution of their investment by allowing them to match any third-party offers.

5 Must Know Facts For Your Next Test

1. ROFR is commonly included in shareholder agreements, ensuring that existing shareholders can preserve their control over ownership decisions.
2. When a company is sold, the ROFR allows existing investors to review the offer and decide if they want to acquire the stake themselves.
3. The right of first refusal can create a more stable investment environment as it prevents unwanted third parties from acquiring shares without existing shareholders' consent.
4. The specifics of ROFR can vary widely, including how long a shareholder has to exercise the right and under what conditions it applies.
5. In venture capital deals, ROFR serves as an important tool for protecting early investors from losing influence and financial interest as a company grows.

Review Questions

• How does the right of first refusal impact shareholder relations in a company?
  • The right of first refusal significantly impacts shareholder relations by providing existing shareholders with an opportunity to maintain their ownership stakes when new shares are issued or when shares are up for sale. This protection helps to foster trust among shareholders, as they know they have a say in who can become a co-owner of the company. By allowing them to match offers from outside parties, it encourages collaboration and alignment of interests among current investors.
• Discuss how the right of first refusal relates to equity dilution and its significance in investment agreements.
  • The right of first refusal is closely tied to equity dilution because it gives existing investors a mechanism to prevent their ownership percentages from shrinking. When new shares are issued or sold to outside parties, ROFR allows current shareholders to purchase additional shares before they are offered elsewhere. This significance in investment agreements lies in its ability to protect early investors' interests, ensuring they have a chance to maintain control and influence within the company despite new entrants.
• Evaluate the advantages and disadvantages of implementing a right of first refusal clause in investment contracts.
  • Implementing a right of first refusal clause in investment contracts has several advantages, including giving current shareholders assurance that they can maintain their ownership stake and influence over decision-making. It fosters stability and potentially increases investor confidence. However, disadvantages might include limiting the company's flexibility to sell shares quickly or attract new investors, as potential buyers may be deterred knowing they must contend with existing shareholders' rights. Balancing these pros and cons is essential for effective negotiation and ensuring long-term business success.

Related terms

Equity Dilution: The reduction in existing shareholders' ownership percentage due to the issuance of new shares.

Preemptive Rights: Rights that allow existing shareholders to purchase additional shares before the company offers them to outside investors.

Valuation: The process of determining the current worth of an asset or company, often influencing negotiation terms in deals.