Key Takeaways

• A Right of First Refusal is a contractual provision that generally gives an existing party the opportunity to match a third-party offer before a sale proceeds.
• ROFR provisions are common in private companies and may affect liquidity and ownership control.
• These rights operate alongside federal and state securities laws, which may impose separate transfer restrictions.

A Right of First Refusal (ROFR) is a contractual provision that generally gives an existing party the opportunity to purchase an asset before it is sold to someone else. In private markets, ROFR clauses frequently appear in shareholder agreements, investor rights agreements, and company bylaws. They are also used in real estate and joint venture arrangements.

In the context of private companies, a ROFR is often designed to help manage ownership changes and maintain control over who becomes a shareholder. However, the specific terms of a ROFR depend on the agreement and applicable law.

This informational article provides a general overview of how ROFR provisions typically work in the United States.

What Is a Right of First Refusal?

A Right of First Refusal is a contractual right, not an obligation, that allows a designated party to match a third-party offer before a sale proceeds.

In private companies, the ROFR holder is often:

• The company itself
• Existing shareholders
• Major investors such as venture capital firms

If a shareholder receives a bona fide offer from a third party to purchase their shares, the ROFR provision may require the shareholder to first offer those shares to the ROFR holder on substantially the same terms.

If the ROFR holder declines within the stated timeframe, the seller may proceed with the third-party transaction, subject to the agreement’s conditions.

How a Right of First Refusal Generally Works

While terms vary, the process often follows a structured sequence.

Step-by-Step Process

1. Third-Party Offer Received - A shareholder receives an offer from an outside buyer.
2. Notice to ROFR Holder - The selling shareholder must generally provide written notice that includes the material terms of the offer (price, number of shares, payment structure, etc.).
3. Review Period - The ROFR holder has a defined period—often 15 to 30 days—to decide whether to match the offer.
4. Election to Purchase or Decline
    

Timeframes and Conditions

ROFR clauses usually specify:

• Required written notice format
• The response deadline
• Whether the offer must be matched exactly
• Whether partial exercise is permitted

If the seller changes the deal terms materially, the ROFR process may need to restart.

Where ROFR Is Commonly Used

Private Company Shares

ROFR provisions are particularly common in venture-backed startups and closely held corporations. They may help:

• Maintain ownership concentration
• Prevent transfers to competitors
• Allow existing investors to preserve their percentage ownership

In early-stage companies, ROFR provisions often appear alongside other transfer restrictions.

Real Estate Agreements

In real estate, landlords or co-owners may hold a ROFR on property interests. If an owner decides to sell, the holder generally has the opportunity to purchase before outside buyers.

Mergers, Acquisitions, and Joint Ventures

Strategic partners in joint ventures sometimes negotiate ROFR rights to maintain influence if a partner exits.

ROFR in Private Investing and Crowdfunding

In private investing, ROFR provisions are often tied to broader securities law considerations.

Early-Stage Companies

Many venture capital term sheets include ROFR provisions covering secondary share sales. This may affect the liquidity of founders and early employees who wish to sell shares before an IPO or acquisition.

Regulation D, Regulation CF, and Regulation A Context

Share transfers in private companies are generally subject to federal securities laws administered by the SEC. Depending on how the securities were originally offered, such as under Regulation D, Regulation Crowdfunding (Reg CF), or Regulation A, transfer restrictions may apply.

For example:

• Regulation D securities are typically “restricted securities” and may not be freely transferable without registration or an exemption.
• Regulation CF securities generally have a one-year transfer restriction, subject to limited exceptions.

A ROFR operates contractually, but it does not override applicable securities regulations. Any transfer must comply with both the contractual agreement and federal and state securities laws. In some cases, broker-dealers or funding portals regulated by FINRA may be involved in facilitating transactions.

Advantages and Potential Limitations of ROFR

Potential Benefits

ROFR provisions may:

• Allow existing shareholders to maintain ownership percentages
• Help companies manage their cap tables
• Reduce the likelihood of unwanted third-party shareholders
• Provide visibility into pending share transfers

Potential Limitations

However, ROFR provisions may also:

• Slow down transaction timelines
• Reduce liquidity for selling shareholders
• Discourage third-party buyers who prefer certainty
• Add administrative complexity

The overall impact depends on how the provision is drafted and enforced.

ROFR vs. Similar Contractual Rights

ROFR provisions are sometimes confused with other rights.

ROFR vs. Right of First Offer (ROFO)

A Right of First Offer typically requires the seller to first approach the rights holder before negotiating with third parties. In contrast, a ROFR is triggered after a third-party offer is obtained.

ROFR vs. Tag-Along Rights

Tag-along rights generally allow minority shareholders to participate in a sale initiated by a majority shareholder.

ROFR vs. Drag-Along Rights

Drag-along rights generally allow majority shareholders to require minority holders to participate in a company sale under specified conditions.

Each provision serves a different governance purpose and is often included in shareholder agreements.

Practical Example

Consider a private startup with three investors. One investor receives an offer from an outside buyer to purchase 100,000 shares at $5 per share.

Under the shareholder agreement:

• The investor must notify the company and other investors.
• The company has 20 days to match the offer.

If the company elects to exercise its ROFR, it purchases the shares at $5 per share under the same terms. If it declines, the original investor may proceed with the outside buyer, assuming compliance with securities regulations and any additional contractual requirements.

This example is simplified. Actual agreements often contain more detailed conditions.
 

FAQs

1. Is a Right of First Refusal required in private companies?
No. ROFR provisions are typically negotiated and included in shareholder agreements. They are not automatically required under U.S. corporate law.

2. Does a ROFR guarantee that an existing shareholder will acquire the shares?
Not necessarily. The holder must generally match the specific terms of the third-party offer within the defined timeframe.

3. Does a ROFR eliminate securities law requirements?
No. Share transfers in private companies must still comply with applicable federal and state securities laws, including transfer restrictions and exemption requirements.

Conclusion

A Right of First Refusal is a common contractual mechanism used in private markets to manage ownership changes. It generally provides existing stakeholders with an opportunity to purchase shares before they are transferred to outside parties. However, its practical effect depends on the specific language of the agreement, the company’s structure, and applicable securities regulations.

Disclaimer: This article is provided for informational and educational purposes only and does not constitute legal, tax, investment, or financial advice. Nothing in this content should be interpreted as a recommendation, solicitation, or offer to buy or sell any securities. Securities transactions involve risk, including the potential loss of capital, and may be subject to restrictions under the Securities Act of 1933, state securities laws, and other regulatory requirements.