The success of a business is not solely determined by its product or service; rather, it is often intricately linked to the harmony among its shareholders. A well-drafted shareholders' agreement can help prevent conflict and ensure the smooth operation of the company. Two crucial provisions within such agreements are the Right of First Offer (ROFO) and the Right of First Refusal (ROFR). These provisions, while seemingly similar in their focus on the transfer of shares, possess distinct functionalities and present unique advantages and disadvantages. Let's explore how each provision works and how shareholders can navigate the decision-making process effectively.
Understanding Right of First Offer (ROFO):
ROFO, or the Right of First Offer, grants non-selling shareholders the pre-emptive right to purchase shares before soliciting external parties. Here's how it works: when a selling shareholder intends to sell their shares, they are obligated to first offer them to existing shareholders. Only if the offer is declined by the non-selling shareholders can the selling shareholder then seek third-party offers and proceed to sell, but only on terms that are not less favourable than the offer initially presented or subsequently negotiated and concluded with the non-selling shareholders.
Key features of ROFO:
Under a ROFO, a selling shareholder is obligated to offer their shares to the existing shareholders before seeking alternative buyers.
Non-selling shareholders have the first right to purchase shares that another shareholder wants to sell.
If non-selling shareholder decline to buy the shares, the selling shareholder becomes free to sell them to the third party buyer at the same or price higher than offered to the non-selling shareholders.
Advantages of ROFO:
Maintains control within the existing shareholder group: ROFO allows existing shareholders to maintain ownership concentration by exercising their purchase rights.
Protects existing shareholders: ROFO ensures fairness and price consistency by prohibiting the selling shareholder from offering better terms to outside buyers compared to those offered to the non-selling shareholders.
Potentially benefits selling shareholder: ROFO may incentivize the seller to offer a higher price to the existing shareholders, knowing they have the first option.
Disadvantages of ROFO:
Can limit selling shareholder's options: The selling shareholder is restricted from directly seeking the best possible offer from the market.
May lead to delays in the sale: Negotiations with existing shareholders can take time, potentially impeding the selling shareholder's exit strategy.
Potential for conflicts: If multiple existing shareholders are interested in buying, disagreements over price or allocation can arise.
Understanding Right of First Refusal (ROFR):
ROFR, or the Right of First Refusal, empowers non-selling shareholders to match the terms of an offer made by a selling shareholder to a third-party buyer. Here's how it works: After the selling shareholder has solicited an offer from an external party, they must present the same offer to the existing shareholders. These non-selling shareholders then have the option to accept the offer and purchase the shares on the same terms as the third-party buyer.
Key features of ROFR:
With a ROFR, a selling shareholder is not obligated to offer the shares to existing shareholders first.
The selling shareholder can negotiate and receive offers from any third party buyer they choose before presenting the offer to non-selling shareholders.
The existing shareholders have the right to match the terms of sale received from the third party and purchase the shares themselves.
Advantages of ROFR:
Provides flexibility for selling shareholder: The selling shareholder enjoys greater freedom to negotiate and secure the best possible sales terms.
Faster sales process: ROFR avoids the potential delays associated with negotiations with existing shareholders in a ROFO scenario.
Minimizes risk of conflict among existing shareholders: Since existing shareholders only have a matching right, it reduces the likelihood of disputes over price or allocation.
Disadvantages of ROFR:
Limited Negotiation Freedom: The seller's negotiation flexibility is restricted because they are required to present any offer from third party to existing shareholders before initiating sale to third party. This constraint may impede the seller's ability to secure the most favorable terms for the share sale.
Sale Process Delays: The obligation to offer shares to existing shareholders before pursuing third-party offers can prolong the sale process, which may not align with the seller's desire for a swift liquidation of their investment
Selling shareholder may receive lower offer: ROFR removes the incentive for the buyer to offer a higher price to existing shareholders as they have the matching right.
Choosing Between ROFO vs ROFR:
The choice between ROFO (Right of First Offer) and ROFR (Right of First Refusal) depends on several factors, including the selling shareholder's position and goals. For instance, if a selling shareholder is a minority shareholder and lacks information or expertise to accurately gauge their shares' fair market value, a ROFO can be beneficial. Conversely, if the selling shareholder has a strong network, they might be able to quickly secure a good offer from a third party. In this case, a ROFR is preferable, as it allows them to present that offer to existing shareholders, who then must match it or decline.
In simpler terms, the following factors can help in decision-making:
Desired ownership control: If maintaining control within the existing group is a high priority, ROFO provides stronger guarantees.
Sale Process Efficiency: ROFO can expedite the sales process in contrast to ROFR, as the selling shareholder can save time by bypassing negotiations and securing an offer from a third party.
Risk tolerance for potential conflicts: If conflict resolution is a concern, ROFR may be preferable due to its simpler structure.
In conclusion, both ROFO and ROFR serve important roles in protecting shareholders' interests and maintaining the stability of ownership within a company. The decision on which mechanism to include in a shareholders' agreement depends on various factors such as the nature of the business, shareholder dynamics, long-term goals, and legal considerations. By carefully assessing these factors and seeking professional advice when needed, shareholders can make informed decisions that best suit the needs of their company.