What are Right of First Offer (ROFO)?

When a shareholder decides to sell their shares, the Right of First Offer (ROFO) is a mechanism that ensures existing investors get the first opportunity to buy before the shares are offered to outside parties. It’s a common clause found in shareholder agreements, especially in private companies. ROFO helps existing shareholders maintain control over ownership and prevents new, potentially disruptive investors from coming in without their approval. Understanding how ROFO works can be crucial for both companies and shareholders as they navigate share sales and ownership changes.

What are Right of First Offer (ROFO)?

ROFO, or Right of First Offer, gives existing shareholders the first chance to buy shares before the seller can seek offers from third parties. Unlike the Right of First Refusal (ROFR), where a third-party bid is needed before current shareholders are approached, ROFO requires the seller to offer the shares to shareholders with ROFO rights first.  

Only if those shareholders decline can the seller, then turn to outside buyers. This mechanism ensures that current shareholders have the opportunity to maintain or increase their stake without outside competition entering the process initially.

How Right of First Offer (ROFO) works?

When a shareholder wants to sell, they must first offer the shares to those holding the Right of First Offer (ROFO) before seeking outside bids. After receiving this offer, the ROFO holders have the option to bid at a set price. The seller then has two choices: either accept the bid from the ROFO holders or go to the open market to seek higher offers.  

However, the seller can only proceed with external buyers if they receive a bid higher than what was offered by the ROFO shareholders. This process ensures that existing shareholders have the first opportunity to purchase but doesn’t limit the seller from potentially securing a better deal elsewhere.

If no ROFO holder makes an offer within the specified timeframe, the seller is typically free to negotiate with external buyers without restrictions. It’s important to note that the ROFO doesn't give the existing shareholders the right to match any third-party offers but rather gives them the first chance to make an offer.

Benefits of Right of First Offer (ROFO)

1. Control and Stability: For companies, especially startups or smaller firms, ROFO helps maintain control over ownership. It prevents the sudden entry of external investors, allowing current shareholders to retain influence over company decisions.

2. Avoidance of Ownership Dilution: Current investors get the chance to increase their ownership stake and avoid dilution that can occur when shares are sold to new external shareholders.

3. Incentivizes Strategic Growth: ROFO encourages existing shareholders to invest more, knowing they have the first opportunity to buy additional shares, helping companies raise capital internally without bringing in external investors.

Drawbacks of Right of First Offer (ROFO)

Despite its benefits, ROFO also has some drawbacks:

1. Limited Market Exposure: Sellers may miss out on higher offers from external buyers since they are initially bound to consider only internal offers.

2. Potential for disputes: Disagreements can arise over whether the terms offered to third parties are indeed more favorable than those offered to the ROFO holder.

3. Time-Consuming: The ROFO process can delay transactions, as it often involves waiting periods and negotiations with existing shareholders before the seller can approach external buyers.

Conclusion

In conclusion, the Right of First Offer (ROFO) provides existing shareholders with the initial chance to acquire shares before any external offers are considered. This mechanism differs from the Right of First Refusal (ROFR) in that it requires sellers to approach ROFO holders first. After receiving the offer, shareholders have the option to place a bid for the shares, allowing the seller to either proceed with the existing shareholders or seek higher bids from outside investors. This arrangement empowers current shareholders to maintain their influence while also giving sellers the freedom to pursue potentially better offers in the market.

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