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Understanding Right of First Offer (ROFO) and Right of First Refusal (ROFR)

Updated: Dec 7, 2023

Investing in a company comes with its set of risks and uncertainties. To mitigate these risks and protect the interests of investors, shareholder agreements often incorporate vital provisions such as the Right of First Offer (ROFO) and Right of First Refusal (ROFR).These stand out as essential mechanisms for maintaining control over the ownership and transfer of shares.


Right of First Offer (ROFO)


A right of first offer (ROFO) empowers a selling shareholder to offer their shares to the existing shareholders before seeking external buyers. This mechanism ensures that the existing shareholders have the first opportunity to acquire the shares, maintaining their control over the company's ownership structure.

How it works: If a shareholder intends to sell their shares, they must first offer them to existing shareholders at a price determined in accordance with the agreement. If the existing shareholders decline the offer within a specified period, the shareholder is then free to sell the shares to an external party.

Scenario:

Imagine Company A has three shareholders: Shareholder 1, Shareholder 2, and Shareholder 3. Shareholder 1 decides to sell some of their shares. Before offering these shares to external parties, Shareholder 1 is obligated to offer them first to Shareholder 2 and Shareholder 3 at a predetermined price. If neither Shareholder 2 nor Shareholder 3 wishes to purchase the shares, Shareholder 1 can then sell them to an external party.

Example:

Reliance Industries Limited (RIL)


Reliance Industries Limited (RIL), one of India's largest and most diversified conglomerates, has incorporated ROFO provisions into its shareholder agreement.


Right of First Refusal (ROFR)


A right of first refusal (ROFR) grants the existing shareholders the right to either accept or reject an offer made by a selling shareholder to sell their shares. This provision ensures that existing shareholders have a say in who joins the company's ownership ranks, preventing undesirable third-party acquisitions.

How it works: If a shareholder intends to sell their shares to a third party, they must first inform the existing shareholders of the external offer. The existing shareholders then have the right to purchase the shares on the same terms offered by the external party.

Scenario:

Continuing from the previous example, Shareholder 1 receives an offer from Company X to buy their shares. Before accepting this offer, Shareholder 1 must first inform Shareholder 2 and Shareholder 3 of the offer and give them the opportunity to match the terms. If either Shareholder 2 or Shareholder 3 decides to match the offer, Shareholder 1 must sell the shares to them instead of Company X.

Example:

Infosys Ltd.


Infosys Ltd., a leading Indian IT company, has incorporated ROFR (Right of First Refusal) provisions into its shareholder agreement.


DIFFERENCE BETWEEN ROFO AND ROFR

Importance of ROFO and ROFR for Investors and VCs


1.Preserving Control over Ownership Structure: ROFO and ROFR provisions empower investors and VCs to maintain control over the company's ownership structure. By granting existing shareholders the first opportunity to acquire shares or match external offers, these provisions prevent the dilution of their equity stakes and protect against the introduction of undesirable third parties.


2.Safeguarding Investment Value: ROFO and ROFR provisions safeguard the value of investors' and VCs' investments by ensuring that the company remains in the hands of capable and committed shareholders. These provisions prevent the company from being taken over by a hostile bidder or experiencing a change in leadership that could jeopardize the company's future prospects.


3.Aligning Investor Interests: ROFO and ROFR provisions align the interests of investors and VCs with those of existing shareholders, fostering a more cohesive and collaborative ownership structure. By ensuring that all shareholders have a say in who joins the ownership ranks, these provisions promote a shared vision for the company's future.


4.Facilitating Strategic Partnerships: ROFO and ROFR provisions can facilitate strategic partnerships between investors and VCs by granting them a voice in the selection of new shareholders. This allows investors and VCs to identify and collaborate with individuals who share their vision and expertise, enhancing the company's overall growth trajectory.


5.Enhancing Exit Strategies: ROFO and ROFR provisions can enhance the exit strategies of investors and VCs by ensuring a liquid market for their shares. These provisions provide a mechanism for investors and VCs to sell their shares to existing shareholders, potentially enabling a smoother and more profitable exit.


6.Promoting Long-Term Stability: ROFO and ROFR provisions promote long-term stability within the company by discouraging short-term opportunistic investments. By granting existing shareholders the first opportunity to acquire shares, these provisions incentivize long-term commitment and foster a culture of sustainable growth.


7.Protecting Intellectual Property: ROFO and ROFR provisions can indirectly protect the company's intellectual property by preventing the transfer of shares to individuals or entities with conflicting interests. This safeguard helps maintain the confidentiality and integrity of the company's proprietary knowledge and innovations.


8.Enhancing Reputation and Credibility: ROFO and ROFR provisions can enhance the company's reputation and credibility among investors and stakeholders by signaling a commitment to responsible ownership and prudent shareholder practices. These provisions demonstrate that the company values the interests of all shareholders and is committed to long-term success.


Conclusion


ROFO and ROFR provisions play a crucial role in shareholder agreements, safeguarding the interests of existing shareholders, investors, and VCs. By carefully tailoring these provisions to the specific needs of the company, stakeholders can ensure a stable and controlled transfer of ownership, fostering long-term success. Furthermore, these provisions promote a culture of alignment, collaboration, and responsible ownership, ultimately contributing to the company's sustainable growth and enhanced reputation.


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