ROFR meaning in VC

rofr
A ROFR provides the non-selling shareholders with a right to either accept or refuse an offer from a selling shareholder after the selling shareholder has received a third party offer for its shares.

The Right of First Refusal (ROFR) is a provision in startup equity deals that gives a particular investor the first opportunity to invest in additional shares of a company before those shares are offered to other potential investors.

What is the Right of First Refusal When It Comes to Startup Equity?

The Right of First Refusal grants an investor the privilege of being offered shares of the company’s stock before other investors when new shares are issued. It provides the investor with the option to maintain their ownership percentage by buying a proportionate number of shares.

What is ROFR and What is ROFO in Short?

ROFR stands for Right of First Refusal, while ROFO stands for Right of First Offer. Although similar, ROFO gives the investor the opportunity to receive an offer to buy shares before the company offers them to others, but it doesn’t obligate the investor to buy the shares.

Why is a Right of First Refusal Important?

The ROFR is essential for investors to protect their ownership stake in a startup. It ensures they have the first chance to invest in the company’s growth and maintain their position before any dilution occurs due to new investors.

Why Do VCs Want a Right of First Refusal?

Venture capitalists (VCs) seek ROFR provisions to maintain control over their investment and to have a say in the future direction of the startup. It helps them safeguard their interests and influence potential decisions that may impact the company’s value.

How Does a Right of First Refusal Work?

When a triggering event occurs, the investor with the ROFR is notified and has a specified time to decide whether to purchase the offered shares. If they decline, the company can then offer the shares to other potential investors.

The Right of First Refusal (ROFR) operates as follows: If an investor (known as the “selling stockholder”) receives an offer from a potential buyer (referred to as a “third party”) interested in purchasing some or all of their shares, the selling stockholder must inform both the company and the other investors about the offer. This notification includes details such as the number of shares the investor wants to sell (termed “offered shares”), the price, and all other terms of the offer. The company then has a specified timeframe, usually around 15 days, to decide whether it wants to purchase any or all of the offered shares.

Scenario 1: Company Buys All Offered Shares

If the company decides to buy all of the offered shares, the ROFR process ends there. The selling stockholder then sells all of the offered shares to the company on the same terms that were offered by the potential buyer. In this situation, the potential buyer loses out.

Scenario 2: Company Buys Some or None of the Offered Shares

Should the company choose to buy only a portion of the offered shares or decide not to buy any of them (which is common), it must notify the selling stockholder and the other investors about the number of shares it intends to purchase. In response, the other investors are given the right to purchase the remaining shares on the same terms as those offered by the potential buyer. The company includes in the notice the number of offered shares each stockholder can buy, based on their “pro rata” or proportionate ownership as covered by the ROFR.

The stockholders then have a brief period, typically 10 days, to decide whether they will purchase the shares offered to them. Generally, they must either buy all of the offered shares or decline to purchase any; partial purchases are not allowed. If one or more stockholders choose not to buy their allotment of offered shares, the company will send another notice to the stockholders who expressed their intention to buy, giving them the opportunity to acquire the remaining shares.

Ultimately, after this process, the company and the stockholders must indicate their willingness to buy all of the offered shares. If they fail to do so, losing the right to buy any of the offered shares, the selling stockholder will then proceed to sell the shares to the potential buyer.

Reasons to Consider Using a Right of First Refusal

  • Protects investor ownership percentage
  • Allows investors to participate in future growth opportunities
  • Provides a level of control over the company’s direction

Reasons to Consider Not Using the Right of First Refusal

  • May discourage new investors if the ROFR limits their opportunities
  • Could lead to disputes and delays in raising capital
  • Some startups prefer not to have restrictions on share issuance

The Benefit of Rights of First Refusal

The primary advantage of ROFR is that it allows investors to maintain their ownership stakes and continue supporting the company’s growth while also having a say in important decisions.

The Setback of Rights of First Refusal

The main setback of ROFR is that it may limit the startup’s ability to attract new investors, as some investors may be hesitant to invest if their opportunities are restricted by the ROFR clause.

How to Avoid a ROFR

Startups looking to avoid a Right of First Refusal can negotiate with investors to exclude or modify the clause in the investment agreement. However, this negotiation may require concessions or alternative terms.

An Example of Rights of First Refusal

Imagine Company X is looking to issue new shares. According to the ROFR clause, Investor A, who already owns 20% of the company, has the right to purchase up to 20% of the new shares before they are offered to other investors.

Technical Terms in ROFR Provisions

  • Triggering Events: Events that activate the ROFR, such as the issuance of new shares or a proposed transfer of shares.
  • Priority Order: The order in which investors with ROFR can exercise their rights.
  • Transferability: Whether the ROFR rights can be transferred or assigned to another party.

Secondary Issues

ROFR can also be present in secondary transactions, where early investors or employees wish to sell their shares. In such cases, the existing shareholders with ROFR can be given the opportunity to purchase those shares first.

Triggering Transactions

Triggering transactions can include stock sales, mergers, or acquisitions that would result in a change of ownership or dilution of existing shares.

Liquidation Preferences

In some cases, investors with ROFR may also have liquidation preferences, which entitle them to receive their investment back before other shareholders in the event of a liquidation or exit.

Advantages and Disadvantages of Rights of First Refusal

Advantages: Protects investor ownership, allows participation in future growth, and provides control over the company’s direction.

Disadvantages: May limit new investor opportunities and could lead to disputes or delays in fundraising.

Examples

Many venture capital firms and angel investors use ROFR to protect their investments and ensure a long-term relationship with the startups they support.

Right of First Offer (ROFO)

ROFO is similar to ROFR but does not obligate the investor to buy the offered shares. Instead, it gives them the right to receive an offer before the shares are offered to others, providing the option to accept or decline.

Leave a Reply

Your email address will not be published. Required fields are marked *

You May Also Like