Basics of a Right of First Refusal (RoFR)

Ubiquitous in equity agreements is a Right of First Refusal (RoFR). It also tends to be a rather chunky section of the agreement, ranging from a large paragraph to multiple pages (unfortunately, we have seen a 3-page long RoFR). This week, let’s dive into the basics of what it is, how it’s structured, and some of the gotchas to look out for.

What is a Right of First Refusal?

When a company provides private equity to an employee, the equity agreement often includes a RoFR to help the company control who gets ownership of their shares. As a result, any third party offers must first go through company review. Third party sales can only proceed after the company’s ‘first refusal’ to purchase the shares in place of the third party. For example, if a third party is offering you $10 per share for 1,000 shares, your company has the right to purchase those 1,000 shares and stop the third party sale.

What is the structure of a Right of First Refusal clause?

There are 5 components of a RoFR clause:

1. Triggering Condition: RoFR is usually ‘triggered’ when there is a third party offer to buy your equity.

2. Notice Requirement: You must notify the company within X days of this offer and its details such as price and quantity.

3. Company Purchase: Your company typically has Y days to make a decision and purchase the equity in place of the third party at a specific price.

4. Third-Party Sale: In the case that your company opts out, the third-party sale typically has to complete within Z days of notice.

5. Termination Condition: RoFR typically terminates upon IPO.

Let’s take a look at an example summary of a typical RoFR clause:

If a third-party offers to buy your equity, you must notify your Company as they have the right to purchase it instead:

1. Company has 30 days after notice to choose to purchase it at the offered price.

2. If it’s a Company purchase, payment must be made within 60 days of notice.

3. If not, the third-party sale must complete within 90 days of notice.

4. ROFR terminates with an IPO, merger, or acquisition.

You should be able to identify all five components from any RoFR clause. Of course, there can always be non-standard components as well, which we’ll get to next.

What should you look out for in a Right of First Refusal clause?

Take a look at this list sifted from the many RoFR clauses we’ve reviewed:

1. Right of Total Refusal: Some RoFR clauses actually grant your company the right to refuse the sale entirely without opting to purchase in the third party’s place.

2. Unfavorable Purchase Terms: While the standard RoFR honors the price and quantity of the third party, some RoFR may allow the company to purchase at a lower price, limit the quantity you can sell, or have delayed payment terms.

3. Long Decision Period: The longer your company takes to make a decision, the more likely the third party sale will fall through, so a long decision period can effectively prevent third party sales.

4. RoFR Transfer: Similarly, when your company is allowed to transfer their RoFR to someone else, it can also both elongate the decision period and also alter your ability to control the recipient of your shares.

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We fully support a company’s ability to manage ownership of their shares and an individual’s ability to find liquidity in their equity. Both can co-exist without overly encroaching on the rights of the other, which is a balance we believe should exist for contracts broadly. We hope this week’s post helps you break down the page-long paragraph that tends to be the RoFR clause and flag points of negotiation.

For advocacy and beyond,
The Ask Ginkgo Team