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4 alternatives to rights of first refusal clause: A comparison of options for protecting your interests in a business or investment.

Introduction

Investors often use a shareholder agreement to lay out the conditions that govern their relationship with one another. An important difference is the influence of the deal’s value, timeliness, and exchange costs. Controlling the exchange of shares to obfuscate or upset certain persons while retaining liquidity in their shares is one problem that disturbs investors when hammering out a shareholder’s agreement. A rights of first refusal clause (ROFR) or right of first offer (ROFO) is a common tool used to solve this concern (ROFO).

As a result, while launching a real estate firm or brokering a contract for a client, even the slightest difference in terminology counts. It is particularly true when distinguishing between the right of first rejection provision and the right of first offer clause. Are you sure you understand what they mean? Please allow us to explain.

What exactly is the Right of First Refusal Clause?

When a third party proposes to acquire or lease a property owner’s asset, the rights of first refusal clause is frequently triggered. Before the property owner accepts this offer, the property holder (the person with first refusal) must be permitted to purchase or lease the asset under the same conditions as the third party.

Variations on the right of first refusal provisions are also available. In one form, the right of refusal serves as an agreement to lease or purchase property at a price determined by one or more appraisals when the provision is activated.

The property holder may also agree to pay a portion of the current value agreed upon between the holder and the sale when the right of refusal was negotiated.

Similarly, the right of first refusal venture capital may provide the holder with the contractual right to match any offer received by the seller, albeit they may opt not to use that right. It takes us to a similar phrase known as “right of first offer,” which is sometimes confused with or misunderstood for the rights of first refusal clause.

First Right of Offer

When a property owner wishes to sell or lease an asset, the right of first offer is often used. It gives the property owner the first opportunity to purchase or lease the asset before it is offered to a third party. The property owner may accept or reject the holder’s offer but must allow them to purchase or lease.

It might also refer to as the “right to first negotiation.” It implies that the property holder has the first right of refusal on the item if the property owner chooses to sell or lease it on their own.

The owner must not accept that offer but must comply with the contractual requirement of offering the holder’s first bid.

Right of first refusal example:

As an example, 1. License and Leave Agreement

A is the Landlord of property “X,” and B is the Tenant of the same. There is a stipulation in the leave and licence agreement between A and B that states that B has the first right to acquire or decline the offer if A sells this property. So, now that A is selling this property and has received bids from C to purchase it for two crores. As a result, B gets the first right to buy or reject this property for 2 crores. However, B is under no obligation to acquire this property.

4 Alternatives to rights of first refusal clause: 

1) The right to buy shares at the same price as another person:

Employees, directors, and big owners are often granted this privilege. It enables them to purchase firm stock at the same price as a third party. It might benefit employees and shareholders since it enables them to purchase shares at a lower cost.

2) The option to match a third-party offer:

This privilege allows the firm to match any offer a third party makes for the company’s shares. It might be advantageous for the firm since it enables them to retain ownership of their shares.

3) The ability to reject a third-party offer:

This power allows the corporation to refuse any offer a third party makes for the firm’s shares. It might be advantageous for the firm since it enables them to retain ownership of their shares.

4) First right of refusal:

This power allows the firm to reject any offer a third party makes for the company’s shares. It might be advantageous for the firm since it enables them to retain ownership of their shares.

Here is a list of crucial phrases to be aware of in a right of first refusal clause:

Coverage Barrier

Who should have the rights of first refusal clause? 

Typically, only “big investors” are permitted such privileges. For example, only investors with at least 50,000 preferred shares may be eligible.

Transactions That Trigger

What types of transactions would enable holders of the right of first refusal to exercise it? There may be a minimum number of shares that must be sold for the rights to be exercised. Certain rules may provide that the sale of preferred shares (i.e., investor shares) also triggers such right. Others may argue that only common stock sales activate such privilege. Finally, certain investors may request that their right of first refusal be extended to fresh funding rounds, enabling them to avoid dilution.

Personal Preferences for Liquidation

A share sale that results in a change of control of the start-up investing may be considered a liquidation event. In such a circumstance, preferred shareholders may be entitled to full liquidation advantages.

Purchase Price if Exercised

Typically, a party exercising their right of first refusal must acquire their full allocation—or decline the offer outright. It simplifies things and prevents such rights from affecting prospective share transactions.

Priority Order

The corporation, the big investors, or both may be awarded first-refusal rights. When the corporation and the main investors own them, it must be determined who gets priority. If the corporation has precedence, the investors have the second right of refusal, often known as the secondary refusal right.

Periods of Notice and Response

The notice period is the days required for a shareholder to notify ROFR holders of a third-party offer. The response time specifies how many days ROFR holders have to determine whether to use their rights and reply appropriately.

Transferability

It specifies if a ROFR holder may transfer their rights to another party (and under what conditions). ROFRs are often non-transferable in venture funding.

Right Of First Refusal (ROFO)

The rights of first refusal clause gives its holders a significant advantage and inhibits other shareholders’ ability to sell their holdings to other parties. For example, suppose a ROFR is involved. In that case, prospective acquirers may be less interested in negotiating a sale, knowing that the seller would first have to surrender their stock to the ROFR holders. In summary, rights of first refusal clause may severely constrain the flexibility and liquidity of ordinary shareholders.

The ROFO—right of the first offer—is a more founder-friendly alternative to the ROFR. Before looking for third-party proposals, ROFO holders have the right to make an offer for the selling shareholder’s stock under a ROFO clause (a ROFR offer happens after the third-party offer is made).

Bottom Line

The right of first refusal clause safeguards the interests of investors and is crucial. If the founders want to leave the firm due to unforeseen circumstances, investors should be able to acquire the founders’ interest initially. Tykeinvest can help you in this as they will take care of  with the term sheet terms and conditions ,the  language it contains , so that the founders cannot leave before the lock-in time.

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