Right of First Refusal Versus Right of First Offer – The Difference Is Important
In various contexts, one may face a choice between offering or accepting a right of first refusal (ROFR) and a right of first offer (ROFO). In that situation, understanding the legal and practical distinctions between the two concepts is critical, as the two provide very different rights. A ROFR or ROFO can be used in many contexts.
What Is Right of First Refusal?
The right of first refusal is a contractual right that gives an individual or entity the right to match an offer to sell before the asset is sold. This means that if the owner receives an offer from a third party, the holder of the ROFR has the right to match the offer before the transaction can be completed.
What Is Right of First Offer?
The right of first offer is a similar contractual right that instead gives the holder the right to make an offer to buy when the owner of the asset decides to sell it. However, the owner is not obligated to sell to the holder of the ROFO if they do not like the offer.
For illustrative purposes, in this article we will address the nature and operation of a ROFR or ROFO in the common situation in which one private company founder (ROFR Founder) has a ROFR over any sale of equity by the co-founder to a third party (Selling Founder).
In this situation, a Selling Founder that wants to sell all or part of its equity cannot close upon a sale to a third party (“Potential Buyer”) until the Selling Founder offers the ROFR Founder the ability to purchase the equity on the same definitive terms agreed upon by the Selling Founder and Potential Buyer. A ROFR can be triggered by an unsolicited offer by a third party that the Selling Founder has chosen to accept (subject to the ROFR) or by a sale initiated and pursued by the Selling Founder.
If the ROFR Founder elects not to exercise its right, the Selling Founder may proceed with the sale to the Potential Buyer. However, if the terms of the sale are modified in a way favorable to a buyer after a presentation to the ROFR Founder, the Selling Founder may be required to again present the opportunity under the ROFR, depending upon the specific language of the ROFR provision.
Understandably, a ROFR greatly complicates the Selling Founder’s attempts to dispose of a portion of its equity. Potential Buyers often are unwilling to advance significantly in purchase discussions, fearing they will spend time and resources negotiating a deal only to find they were a stalking horse. For those Potential Buyers willing to proceed despite a ROFR, the risk such a situation presents would undoubtedly adversely affect the offer price.
A ROFO provides the holder the right to make a baseline offer to the Selling Founder, rather than reacting to price and other sales terms agreed upon by the Selling Founder and a Potential Buyer. A Selling Founder that determines to sell all or a part of his or her equity interest must notify the ROFO holder, who then may put in an offer for the interest. The Selling Founder cannot accept a less favorable offer than the ROFO holder’s offer, but can go out to obtain higher offers and sell to a potential buyer based on those more favorable terms.
A ROFO is far less problematic for a Selling Founder. It does not dissuade potential buyers as greatly as a ROFR, as the potential buyer does not face the stalking horse issue. With a ROFO, the potential buyer knows it will not be forced to expend significant time and effort in due diligence and negotiation on the deal terms, only to see the ROFR holder swoop in and obtain the benefit of the deal.
A ROFR is a stronger protection and better deal for a ROFR Founder, but is not always the right term for the parties in a given circumstance. With this explanation as context, we recommend that you consult counsel on the nuances of the different provisions and how they are drafted.
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