So you've maneuvered through the maze of venture capital and find yourself staring at a term sheet.
Among the terms you encounter: "Right of First Refusal" (ROFR).
What is it, why should you care, and how do you navigate it? Let's get into it, shall we?
What is a Right of First Refusal (ROFR)?
The Right of First Refusal is a contractual right that gives an investor (or shareholders) the option to buy shares before the owner sells them to an external third party.
In plain English, if you or any other investor in your company are considering selling some of your company's shares, your investor with ROFR gets to say, "Hold on, let me match that offer," before you go ahead with the deal.
Why Does ROFR Matter?
ROFR can serve as a protective measure, ensuring that you maintain a cohesive and strategically aligned investor base. It stops you from ending up with an unknown third-party shareholder that you may not want.
From an investor's perspective, ROFR is a way to maintain their ownership percentage in your company, particularly if they think your startup is the next big thing.
Navigating the ROFR Landscape
Generally, the ROFR clause will specify a time frame within which the investor has to exercise their right. This could range from a couple of days to a few weeks. Make sure the timeline is practical for your plans.
The ROFR is usually triggered when a third party makes a bona fide offer to purchase your shares. This is when your existing investors exercise their right (or not).
The investor with the ROFR usually has the right to purchase the shares at the same price, terms, and conditions offered by the third-party buyer. Ensure that the process for determining this price is clearly outlined in your agreement.
There might be cases where the ROFR doesn't apply, such as transferring shares to family or in cases of an IPO. Be aware of these exceptions.
Things to Watch Out For
- Valuation Implications: If your investors have the right to match any offer you get, this can potentially deter new investors, affecting your valuation and how easily you will raise future rounds.
- Complexity in Sales: Having multiple investors with ROFR can complicate any sale process, causing delays.
- Legal Advice is Crucial: The terms around ROFR can be nuanced and complex. Consult with a legal advisor who has expertise in venture deals to make sure you're not painting yourself into a corner.
- Protection and Limitation: ROFR can both protect and limit you. Know how to use it to your advantage.
- Be Clear on Terms: Make sure that you understand the timelines, triggers, and pricing mechanisms involved.
- Legal Guidance: Always seek expert advice to navigate the complexities.
ROFR is more than just legalese; it's a strategic term that can influence your company's future and your relationship with your investors. Understand it, negotiate it wisely, and as always, may the terms be ever in your favor.
To Go Further
Definitely read “Venture Deals” from Brad Feld and Jason Mendelson